Fiduciary advocates give it high marks for capturing the full range of conduct that should be subject to a fiduciary standard

Jan 23, 2019 @ 5:09 pmBy Mark Schoeff Jr.

A proposed regulation to raise advice standards in Nevada for stock brokers and financial advisers is receiving high marks from fiduciary advocates.

Last week, the Nevada Securities Division released the eight-page regulation proposal to implement a law enacted in 2017 that requires brokers to meet a fiduciary duty when working with their clients.

The Nevada rule is expansive in defining financial advice as well as the circumstances in which brokers would commit fiduciary breaches.

The state is moving ahead with the measure while the Securities and Exchange Commission continues to work on its advice reform proposal — a three-part package that would continue to regulate investment advisers as fiduciaries while requiring brokers to act in the best interests of their clients.

A comment period on the Nevada proposal will end March 1. After that, the state regulatory could modify the rule. It's unclear when a final regulation will be released.

"The Nevada fiduciary proposal is stronger and more elegant than the SEC proposal," said Benjamin Edwards, an associate law professor at the University of Nevada-Las Vegas. "It does in eight pages what the SEC needed a thousand pages to do less effectively."

The breadth of the Nevada proposal, which also touches on investment advisers, jumped out to Skip Schweiss, managing director of adviser advocacy at TD Ameritrade Institutional.

"This covers the landscape," Mr. Schweiss said. "There's no getting around being a fiduciary if you're providing advice as a broker or an adviser."

Under the Nevada proposal, brokers must provide an ongoing fiduciary duty to clients if they manage the client's assets or create periodic financial plans, among other factors. Outside of those circumstances, the fiduciary requirement can be transaction-by-transaction.

The Nevada proposal assumes a broker who is dually registered as an adviser acts as an adviser for clients throughout the relationship and must always meet the fiduciary standard.

The fiduciary requirement would apply to brokers across several kinds of job titles and to those who "hold themselves out" as advisers.

"One of the strengths of the regulation is the broad scope of its coverage," said Barbara Roper, director of investor protection at the Consumer Federation of America. "It does a good job of capturing the whole range of broker-dealer conduct that should be subject to a fiduciary standard."

But the expansiveness of the Nevada proposal is a drawback for Lawrence Stadulis, a partner at Stradley Ronon Stevens & Young.

"The regulations were certainly more extensive than we had anticipated," Mr. Stadulis said. "The most surprising aspect was the number of activities that are deemed a breach of fiduciary duty. There are a lot of kinks in the proposed regulation that need to be worked out."

Ms. Roper also said some improvements are needed. A benefit of the SEC proposal is that it would require mitigation of conflicts of interest, although the SEC hasn't outlined how they should be mitigated. The Nevada proposal doesn't touch on mitigation.

"We'd like to see them do more to ensure that conflicts of interest do not inappropriately influence recommendations," she said.

Brian Graff, chief executive of the American Retirement Association, is concerned that the Nevada proposal does not provide an exemption for advice to retirement plans and plan assets governed by federal retirement law. He argues that retirement plan advisers in the state should only have to answer to the federal government.

"Frankly, [the Nevada regulation] is likely to go to litigation if advice with respect to covered plans is not carved out," Mr. Graff said.

Critics of the proposal also are likely to argue in comment letters that the SEC rule should trump state investment advice regulations.

But Mr. Edwards said Nevada is on solid ground.

"It's well within state authority to regulate conduct and protect its citizens from financial fraud," he said.

Other states have introduced investment advice legislation — and New Jersey is considering its own fiduciary regulation.

Will the S.E.C. aid and abet fraud in 2019? A fictionalized grilling of Jay Clayton under truth ether reveals the perils

Will the S.E.C. aid and abet fraud in 2019? A fictionalized grilling of Jay Clayton under truth ether reveals the perils

With brokers the special interest, the simple principle of putting client interests first, gets mangled in the wording. But two can play that game so Ron Rhoades fights back with his pen

December 27, 2018 — 1:40 PM MST by Guest Columnist Ron A. Rhoades

1 CommentWhile Ron Rhoades, RIABiz’s “One-Man Think Tank” was largely silent during 2018 in terms of his writings in industry publications, he has not-so-quietly been advocating at the S.E.C. and to other government agencies, through seven comment letters spanning a mere 318 pages and in several in-person visits to agency heads and staffers.

Before taking a self-imposed vow of silence, Ron Rhoades sounds off on the RIA industry and tells what's it's like to hit a professional wall. Ron advises that 2019 may well be a watershed year, in terms of defining standards of conduct for personal financial advisors – at the U.S. Securities and Exchange Commission, at the U.S. Department of Labor an at several state securities regulators. It will also be a defining year in state regulation of market conduct involving sales of life insurance and annuities and Certified Financial Planners.

In this article, Ron takes the S.E.C. to task for its down-the rabbit hole way of reverting to suitability rules and using mirrors to suggest otherwise. Because no word goes untwisted by the influence of lobbyist cocktails, our Think Thank is going all Socrates here at full-moon Christmas. In other words, Ron Rhoades pulled out his fiction quill to imagine for us an exchange between the chair of a congressional committee and current chair of the Securities and Exchange Commission, Jay Clayton. See: A conversation between a wirehouse advisor and a senior citizen who seeks trust The hypothetical dialogue "would result from proper Congressional oversight – if procedural rules permitted extended questioning, and if those testifying before Congress would not seek to answer evasively and ambiguously," Rhoades tells as preamble to this editor.

Here goes the back and forth related to the S.E.C.’s Regulation BI's attempts to redefine the English language, hence misleading individual investors for all time to place trust in their brokers, even though the actual language of the rule is clear: Only an arms-length (seller-buyer) relationship exists.

Committee Chair: “Welcome, SEC Chair Clayton.”

Mr. Clayton: “Thank you, Madam Chairman.”

Committee Chair: “We are here today to discuss the U.S. Securities and Exchange Commission’s proposed Regulation Best Interest, also known as Reg BI. Mr. Clayton, are you ready for questions.”

Mr. Clayton: “More than ready, Madam Chairman.”

What the &!*#?Committee Chair: “What the &!*# are you doing?”

Mr. Clayton: “Excuse me?”

Committee Chair: “I wish you would not only excuse yourself, but also recuse yourself, for all time.”

Mr. Clayton: “I don’t understand.”

Committee Chair: “That is readily apparent from the language of Reg BI. Why don’t we take it one step at a time.”

Mr. Clayton: “O.K.”

Committee Chair: “Under your direction, the SEC has proposed ‘Regulation Best Interest,’ and since then, the SEC has received dozens of comment letters and is looking to finalize this regulation, is it not.”

Mr. Clayton: “Yes.”

Committee Chair: “And under this proposal, as you testified before another Congressional committee on December 11, 2018, and I quote: ‘Specifically, proposed Regulation Best Interest would enhance broker-dealer standards of conduct by establishing an overarching obligation requiring broker-dealers to act in the best interests of the retail customer when making recommendations of any securities transaction or investment strategy involving securities. Simply put, under proposed Regulation Best Interest, a broker-dealer cannot put her or his interests ahead of the retail customer’s interests. The proposal incorporates that key principle and goes beyond and enhances existing suitability obligations under the federal securities laws. To meet this requirement, the broker-dealer would have to satisfy disclosure, care and conflict of interest obligations.’”

Mr. Clayton: “That was my testimony, Madam Chair.”

Committee Chair: “Mr. Clayton, are you aware that in a December 2, 2015 hearing before the Subcommittee on Health, Employment, Labor, and Pensions, of the U.S. House Education and Workforce Committee, Rep. Suzanne Bonomaci, questioning securities and insurance industry executives, inquired: ‘Just to be clear, does everyone agree that a ‘best interests’ standard means a ‘best interests fiduciary standard?’ And, are you aware that each of the industry executives then answered in the affirmative?”

Mr. Clayton: “I was not aware of that, Madam Chair.”

Committee Chair: “In your own testimony, you have stated that brokers, under your Proposed Reg BI, will be ‘required to act in the best interests of the retail customer.’ Does this not mean that brokers will possess a fiduciary duty of loyalty to their customers?”

No obligationMr. Clayton: “No, it does not. No fiduciary obligation is imposed.”

Committee Chair: “Despite the fact that under Section 913 of The Dodd Frank Act of 2010, the Congress expressly provided the SEC with the authority to impose a fiduciary standard upon brokers who provide personalized investment advice that is no less stringent than the standard for investment advisers?”

Mr. Clayton: “Correct, Madam Chair. The Commission has decided to not go down that path, at this time.”

Committee Chair: “But, you do require brokers to place their customers interests ahead of their own, under Reg BI, is that not true?”

The best interest obligation in paragraph (a)(1) shall be satisfied if:

(i) Disclosure Obligation. The broker, dealer, or natural person who is an associated person of a broker or dealer, prior to or at the time of such recommendation, reasonably discloses to the retail customer, in writing, the material facts relating to the scope and terms of the relationship with the retail customer, including all material conflicts of interest that are associated with the recommendation.

(ii) Care Obligation. The broker, dealer, or natural person who is an associated person of a broker or dealer, in making the recommendation exercises reasonable diligence, care, skill, and prudence to:

(A) Understand the potential risks and rewards associated with the recommendation, and have a reasonable basis to believe that the recommendation could be in the best interest of at least some retail customers;(B) Have a reasonable basis to believe that the recommendation is in the best interest of a particular retail customer based on that retail customer’s investment profile and the potential risks and rewards associated with the recommendation; and(C) Have a reasonable basis to believe that a series of recommended transactions, even if in the retail customer’s best interest when viewed in isolation, is not excessive and is in the retail customer’s best interest when taken together in light of the retail customer’s investment profile.

(iii) Conflict of Interest Obligations.(A) The broker or dealer establishes, maintains, and enforces written policies and procedures reasonably designed to identify and at a minimum disclose, or eliminate, all material conflicts of interest that are associated with such recommendations.(B) The broker or dealer establishes, maintains, and enforces written policies and procedures reasonably designed to identify and disclose and mitigate, or eliminate, material conflicts of interest arising from financial incentives associated with such recommendations.

Mr. Clayton: “That is Reg BI’s safe harbor, Madam Chair.”

Committee Chair:

“So, when a conflict of interest is present, let’s review the broker’s obligations under the safe harbor. First, there must be disclosure of the conflict of interest.”

Mr. Clayton: “Yes.”

Committee Chair:

“But there does not exist, in this part of the rule, any obligation to avoid a conflict of interest, nor is there a requirement – as exists under fiduciary law – to provide affirmative disclosure of a conflict of interest in a manner that ensures client understanding of the conflict of interest, and obtaining the informed consent of the client?”

‘Best interest’ standard is not ...Mr. Clayton:

“That is correct, Madam Chair. The broker’s ‘best interest’ standard is not a fiduciary standard.”

Committee Chair:

“Second, the broker must exercise reasonable diligence, care, skill, and prudence in order to possess a ‘reasonable basis to believe that the recommendation is in the best interest of a particular retail customer.’ Is ‘reasonable basis’ defined by the rule, and is the term ‘best interest’ defined by the rule?

Mr. Clayton: “No, those terms are not defined in the rule itself.”

Committee Chair: “And is it not true that this second set of obligations – what might be called the ‘care obligation’ - is based upon existing reasonable-basis, customer-specific, and quantitative suitability obligations.”

Mr. Clayton:

“Correct, this care obligation of the broker is closely analogous to the suitability standard.”

Committee Chair: “So, in applying this new standard, how would it be applied differently than the suitability obligation?”

Mr. Clayton: “The broker must act in the ‘best interests’ of the customer.”

Committee Chair: “Who will be the primary enforcer of this new ‘best interest” standard upon broker-dealers?”

Mr. Clayton: “The broker-dealer firms’ self-regulatory organization, the Financial Industry Regulatory Authority, or FINRA, by means of examination and enforcement actions. The rule will also be enforced in arbitration hearings when customers bring complaints.”

Committee Chair: “And those arbitration hearings are governed by FINRA rules, are they not?”

Mr. Clayton: “Yes.”

Committee Chair: “Yet, as FINRA stated in its comment letter to the SEC on Reg BI, FINRA's suitability rule already implicitly requires a broker-dealer's recommendations to be consistent with customers' best interests.”

Mr. Clayton: “FINRA has taken the position since May of 2012 that, and I quote from FINRA’s release, ‘The suitability requirement that a broker make only those recommendations that are consistent with the customer's best interests prohibits a broker from placing his or her interests ahead of the customer's interests.’”

One example, please!Committee Chair: “I see. So, in essence, the term has already been defined by FINRA, and FINRA already has a rule in place that imposes this ‘best interests’ obligation.

So, Mr. Clayton, here’s my question. What is different? Give me examples of how brokers’ conduct will be changed under this duty of care, from what brokers are obligated to do currently?”

Mr. Clayton: “Uh … uh …”

Committee Chair:

“So we have here a rule, that will be predominately enforced by FINRA, the broker-dealer’s own organization, that does not actually impose any substantial new obligations under brokers.”

Mr. Clayton: “But, Madam Chair, there does exist a duty to mitigate conflicts of interests under Reg BI.”

Committee Chair: “Yes, that seems true. Let’s return to the safe harbor. Third, the brokerage firm must adopt certain policies and procedures ‘designed to identify and disclose and mitigate, or eliminate, material conflicts of interest arising from financial incentives.’ Is the extent of ‘mitigation’ defined by the rule?”

Committee Chair: “Let’s stop right there, Mr. Clayton. I knew you were going to point to the flowery language contained in your release of proposed Reg BI, SEC Release No. 34-83062.

That flowery language, found throughout the release, seems to make the rule very appealing to individual investors and consumer advocates. That language appears to make the rule sound like it imposes very substantial obligations upon brokers. But, in point of fact, the language in the release is not part of the rule itself. So, when Reg BI, if it is finalized, is adopted, FINRA arbitrators will only be required to look to the language of the rule itself, and how the term ‘best interest’ has been interpreted by the broker-dealer firms’ own organization, FINRA. Is that not correct.”

Mr. Clayton: “That is substantively correct, Madam Chair. But, again, for the first time there is a requirement, under Reg BI, that brokers mitigate their conflicts of interest.”

Committee Chair: “Not true, Mr. Clayton. There is only a requirement that brokerage firms adopt policies and procedures to this effect. And mitigation might exist, for example, by mere disclosure of the conflict of interest.”

Mr. Clayton: “That was not my intent. The intent of Reg BI is to mitigate the most substantial conflicts of interest that currently exist in brokerage firms.”

Committee Chair:

“But, as stated by the Financial Services Institute in its comment letter to the SEC regarding Reg BI, nothing in the rule would ‘per se prohibit a broker from transactions involving conflicts of interest, including for example: receiving commissions or transaction-based compensation, recommending proprietary products, principal transactions, or complex products.’ In fact, the rule imposes no substantive restriction on the most insidious conflicts of interest present in the brokerage industry today, is that not correct?”

Mr. Clayton: “Madam Chair, I … I … disclosures of conflict of interests must exist.”

Committee Chair: “I see. Mr. Clayton, is the form of disclosure of conflict of interest set forth under the rule?”

Mr. Clayton: “No, it is not.”

Committee Chair: “Let’s examine how a brokerage firm and its brokers, other than the generic disclosures contained in your proposed Form CRS, would be required to satisfy its disclosure obligations to its customers. Suppose a brokerage firm sold a mutual fund to a customer for which the brokerage firm receives compensation in the form of commissions, 12b-1 fees, payment for shelf space, soft dollars, and sponsorship of educational events such as a brokerage firm’s own educational conference sessions as well as sponsorship of seminars that market to new customers. Is the firm required under this proposed Reg BI to disclose to the customer the amount of compensation it receives from the mutual fund company, in total?”

Mr. Clayton: “No.”

Committee Chair: “Is the brokerage firm required under Reg BI to disclose to the customer each type, or form, of compensation it receives, from the mutual fund company?”

Mr. Clayton: “No, Madam Chair.”

Committee Chair:

“Is the brokerage firm required to disclose that it gets paid more to sell some products than other products?”

Mr. Clayton:

“No, Madam Chair.”

Committee Chair: “Could the brokerage firm, in essence, satisfy this obligation of disclosure of material conflicts of interest, found under your proposed BI, by just using the wide-criticized disclosure that the Commission proposed back in 2005 in connection with the ill-fated ‘Merrill Lynch rule’ … a form of ‘casual disclosure’ in which a broker might just state: ‘Our interests may not be aligned with yours’? And, as FSI suggests, ‘it is enough to disclose that different products are available with different costs,’ while not expressly disclosing all of the specific costs and specific types or amounts of compensation received by the brokerage firm and its brokers?”

Mr. Clayton: “We have not defined the extent of a broker’s specific disclosure obligations in Reg BI.”

Committee Chair: “Even if you did so, is it not true that disclosures possess limited effectiveness in protecting consumers, Mr. Clayton?”

Committee Chair: “But not the basis of the Investment Advisers Act of 1940, and the fiduciary obligations imposed upon those who provide investment advice, Mr. Clayton. In fact, in situations where there is a vast disparity of knowledge and expertise in a complex environment, such as the capital markets today with its myriad of different investment strategies and often extremely complex securities, disclosures are not effective as a means of consumer protection. If disclosures were effective, in essence there would be no reason for the fiduciary standard of conduct to exist under the law, and no reason for the Investment Advisers Act of 1940, is that not true?”

Mr. Clayton: “I’m not certain I follow you, Madam Chair.”

Efficacy of disclosures...umCommittee Chair: “Come now, Mr. Clayton. You are the Chair of the SEC. Certainly you are aware of the huge amount of academic research concluding that disclosures are largely ineffective as a means of consumer protection when investment advice is being provided?”

Mr. Clayton: “But brokers are only providing incidental advice, and as such are exempt from the application of the Investment Advisors Act of 1940, Madam Chair.”

Committee Chair: “Is that so? The Advisers Act’s exclusion for broker-dealers only provides an exclusion for ‘solely incidental’ or ‘merely incidental’ advice, is that not correct?”

Mr. Clayton: “Yes, Madam Chair. And we have interpreted that to mean any advice that is ‘in connection with’ and ‘reasonably related to’ a brokerage transaction.

Committee Chair: “Mr. Clayton, words have meaning. The words ‘solely incidental’ appear to have been redefined out of existence, by the SEC’s interpretation. And now, in Reg BI, the Commission exacerbates this mistake. Regulation Best Interest as proposed repeatedly characterizes the broker-dealer model as a ‘model for advice.’ You suggest that preserving the broker-dealer model is all about ‘preserving investor choice across … advice models.’ And you further note in Reg BI that the broker-dealer model is ‘an option for retail customers seeking investment advice.’ In point of fact, did you not yourself recently state that brokers are in an ‘advice relationship’ with their customers.”

Mr. Clayton: “Madam Chair, you are quoting me out of context.”

Committee Chair: “Then let me quote your recent testimony, under oath, before this Congress, in which you stated,

‘Broker-dealers and investment advisers both provide investment advice to retail investors, but their relationships are structured differently and are subject to different regulatory regimes. However, it has long been recognized that many investors do not have a firm grasp of the important differences between broker-dealers and investment advisers ….’

Mr. Clayton, has not the SEC, over the past several decades, failed to draw a line between what is a seller-purchaser, arms-length relationship, such as exists between brokers and their customers, and what is a fiduciary-client, or investment adviser-client, relationship?”

Mr. Clayton: “We have drawn that line. If special compensation is received, such as ongoing asset-based compensation, by a broker, that broker must register under the Advisers Act and is subject to the Advisers Act’s fiduciary duties.”

12b-1 feesCommittee Chair: “Ah, the receipt of ongoing asset-based compensation is where you draw the line. So brokers cannot should not be receiving 12b-1 fees, such as those found in Class C shares, which are often 1% a year of the amount of the assets being managed, without being held to the Advisers Act and its fiduciary standard?”

Mr. Clayton: “That is not the position we have taken. 12b-1 fees are a form of commission.”

Committee Chair: “Mr. Clayton, what you are saying is that brokers can receive ongoing compensation, such as a 1% a year fee paid by a mutual fund the investor owns, for nearly any amount of investment advice they provide, without any real limit on the amount of the advice provided, and are still eligible for the broker-dealer exemption. I may be just an old country lawyer, but I know this – if it walks like an ugly duck and swims like a ugly duck and quacks like an ugly duck, that bird is and must be a duck. Even you, Mr. Clayton, the all-mighty Chair of the SEC, can’t turn that ugly duck into a white swan.”

Mr. Clayton: “If you say so, Madam Chair.”

Committee Chair: “Let’s get back to your over reliance on disclosure. Do you think consumers read, and understand, even basic disclosures of mutual fund costs and their impact upon the returns of the fund?”

Mr. Clayton: “That is the purpose of the disclosures.”

Committee Chair: “Then you must be aware of the two research studies undertaken by Professors James Choi, David Laibson, and Brigitte Madrian, ‘Why Does the Law of One Price Fail? An Experiment on Index Mutual Funds.’ In these research studies the subjects – Wharton MBA and Harvard students – were each given $10,000 to allocate across four S&P 500 index funds and were to be rewarded for their portfolio's subsequent return, but such research demonstrated that the studies’ participants overwhelmingly failed to minimize fees.”

Mr. Clayton: “Those are just two studies, Madam Chair.”

Mythology 101Committee Chair: “But, Mr. Clayton, there are so many more. In fact, the SEC’s emphasis on disclosure results from the myth that investors carefully peruse the details of disclosure documents that regulation delivers. However, under the scrutinizing lens of stark reality, this picture gives way to an image a vast majority of investors who are unable, due to behavioral biases and lack of knowledge of our complicated financial markets, to undertake sound investment decision-making. As stated by former SEC Commissioner Troy Parades, ‘investors are not perfectly rational … when faced with complicated tasks, people tend to ‘satisfice’ rather than ‘optimize,’ and might fail to search and process certain information.’ And, as Professor Ripken has written, ‘there is doubt that disclosure is the optimal regulatory strategy if most investors suffer from cognitive biases … While disclosure has its place in a well-functioning securities market, the direct, substantive regulation of conduct may be a more effective method of deterring fraudulent and unethical practices.’ And, as Professor Robert Prentice informs us, ‘instead of leading investors away from their behavioral biases, financial professionals may prey upon investors’ behavioral quirks … Having placed their trust in their brokers, investors may give them substantial leeway, opening the door to opportunistic behavior by brokers, who may steer investors toward poor or inappropriate investments.’”

Mr. Clayton: “We can all cite studies, Madam Chair.”

Committee Chair: “What is asked of you, Mr. Clayton, is that you not hand-pick excerpts from studies to justify your intended actions, but that you carefully consider all of the academic research that does exist in your rule-making efforts, to ensure that your proposed regulation is grounded not in hope, but in reality, and that its economic consequences – both large and small – have been appropriately considered.”

Mr. Clayton: “Of course, Madam Chair.”

Committee Chair:

“And what is also required it that you not seek to change the English language, as a means of deceiving the American consumer of investment advice. In the law the phrase ‘best interests’ has meant, for centuries, the fiduciary duty of loyalty. Mr. Clayton, as stated by our own U.S. Supreme Court, in SEC vs. Capital Gains, a case I am certain you are familiar with, ‘The court interprets Section 206 to establish a fiduciary duty which in addition to applying to misrepresentations and omission, also requires the investment advisor to act in the best interests of its clients.’

“Well, I have no idea where you get your definition from, Mr. Clayton. Certainly not from a recognized dictionary. In fact, Black’s Law Dictionary, defines a fiduciary duty as ‘a duty to act with the highest degree of honesty and loyalty toward another person and in the best interest of the other person.’ The meaning of ‘best interests’ as indicative of the fiduciary relationship is universal in other common law countries. As but one example, and as explained in Pilmer v Duke Group, the fiduciary obligation is a pledge, or undertaking, by one party to act in the best interests of the other, and this is what makes fiduciary relationships distinct from other relationships. Mr. Clayton, you seek to destroy the fiduciary standard, by redefining the term ‘best interests’ to mean nothing more than something a bit higher than the low suitability standard.”

Mr. Clayton: “I do not, Madam Chair, have that intention.”

Cardoza's edictCommittee Chair: “But that is what will occur. Should you not, instead, heed the warnings of the great Justice Benjamin Cardoza, who so famously stated that ‘Uncompromising rigidity has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the ‘disintegrating erosion’ of particular exceptions. Only thus has the level of conduct for fiduciaries been kept at a level higher than that trodden by the crowd. It will not consciously be lowered by any judgment of this court.’”

Mr. Clayton: “It is not my desire to erode the fiduciary standard.”

Committee Chair:

“But that is the path that you are on, sir, whether you realize it or not. You seek to upend centuries of established jurisprudence with one swipe of cloudy ink from your reckless, leaky pen. You seek to have ‘best interest’ to be used by brokers, when in fact they remain in arms-length relationships with their customers.”

Mr. Clayton: “Madam Chair, I must state, Reg BI does – even if only slightly – raise the standard of conduct for brokers, and no one will be harmed by the rule when it is finalized.”

Committee Chair:

“No one is harmed, Mr. Clayton? Not individual investors, who deal with brokers who represent themselves to their customers as acting in the ‘best interest’ of the customer, when in fact there exists no fiduciary duty of loyalty to the customer, and when in fact the interests of the broker-dealer firm, and the broker, can be and remain paramount to that of the customer?”

Mr. Clayton: “Madam Chair …”

Committee Chair: “And certainly, Mr. Clayton, an educated man such as yourself, a graduate of Cambridge with a Masters in Economics, would certainly be aware of the Nobel Prize-winning work of leading economist George Akerlof, who is best known for his article, ‘The Market for Lemons: Quality Uncertainty and the Market Mechanism.’ In this article, Akerlof so clearly demonstrates that in a market – such as that for financial and investment advice – in which a vast asymmetry of information exists, and where a consumer advice that purports to be in the consumer’s ‘best interests’ may not really be keeping the consumer’s best interest paramount or not, it is a natural consequence is that more ‘lemons’ appear in the market. This leads to a rush – not to the top for standards of conduct by providers of investment advice - but rather to the bottom. In other words, what you are really fostering is conduct from those in the gutter. In essence, you will be harming not just the consumers who purchase lemons, but also harming those honest ’40 Act investment advisers who are bound by law under a fiduciary duty of loyalty to their clients, but whose distinction in the marketplace would be obliterated by this proposed Regulation BI.”

Mr. Clayton: “I am familiar with Mr. Akerlof’s work, Madam Chair.”

Brazen misrepresentationCommittee Chair: “And will not this type of brazen misrepresentation – perhaps amounting to a massive fraud upon individual Americans by brokerage firms holding out as acting in their customers’ best interests when in fact such will not be the legal requirement – result in an even greater dissatisfaction by individual investors with all financial advisors, leading investors to not seek out the trusted, expert financial advice they so desperately need, fleeing the capital markets, and leading to a loss of capital formation which will, especially on a cumulative basis over many years, result in far less economic growth?”

Committee Chair: “But these are not connections that are very difficult to draw, Mr. Clayton; this is fundamental economics. As Professor Columbo stated in a 2010 paper on reforming securities litigation, ‘Trust is a critically important ingredient in the recipes for a successful economy and a well-functioning financial services industry.’”

Mr. Clayton: “You are very well-read, Madam Chair.”

Committee Chair:r: “Someone in government should be, Mr. Clayton. Would you not agree that efforts to improve securities regulation should be informed by insights from economics and from other academic disciplines, Mr. Clayton, to ensure our limited government resources are put to best use. In fact, have you not – yourself – just been wasting the SEC’s precious resources, both now, and in the future, should Reg BI be finalized over strong opposition from two of your five Commissioners, since it is clear that a future SEC under a new Administration will have to unwind and fix the mess you are creating with this deeply malevolent rulemaking?”

Mr. Clayton: “The future is always uncertain, Madam Chair.”

Committee Chair:

“Perhaps, Mr. Clayton, but perhaps your own future is something you have been deeply thinking about. Mr. Clayton, I would now like to unveil how proposed Regulation Best Interests came to be. Is it not true that Regulation Best Interests was derived in large part from a proposal advanced by the Financial Services Institute and SIFMA, both broker-dealer industry lobbying organizations?”

Mr. Clayton: “Madam Chair, you appear to overstate their influence.”

Committee Chair: “But, Mr. Clayton, did not FSI and SIFMA propose actual language for a ‘Best Interest’ broker standard a few years before, which was subsequently endorsed in major part by FINRA. And did not FSI President Dale Brown himself state in early 2018: ‘Earlier this year we had meetings with [SEC] Chairman Jay Clayton and [SEC Director of the Division of Trading and Markets] Brett Redfearn and we are ... hearing that many of our themes that we’ve hit on in our advocacy’ were finding their way into the SEC’s proposals.”

Mr. Clayton: “He may have been bragging.”

Sullivan & Cromwell ... and conflicts?Committee Chair:

“Chair Clayton, now I would like to understand the motivations behind your advancement of this deeply flawed proposed rule. Before you were appointed to the SEC, you were are partner in the New York City law firm of Sullivan & Cromwell, were you not?”

Mr. Clayton: “Yes.”

Committee Chair: “And while at that firm, you represented the interests of Wall Street firms, investment banks, and broker-dealer firms, such as Goldman Sachs, Bear Stearns, UBS, and Barclays Capital, did you not?”

Mr. Clayton: “Yes, Madam Chair, but …”

Committee Chair: “And, after your service at the SEC, since you are only age 52, is it not highly likely that you will go to work for a large Wall Street firm, or work again for a law firm that represents broker-dealer firms?”

Mr. Clayton: “Madam Chair, that is inherently speculative, and I resent the implication.”

Committee Chair:

“And is it not true that many, if not most, of the attorneys on the staff of the U.S. Securities and Exchange Commission who worked on this proposal, have either worked for broker-dealer firms, for law firms that represented broker-dealer firms, or will likely depart the SEC at some time in the future to join such broker-dealer firms or their legal counsel?”

Mr. Clayton: “Madam Chair, the SEC requires industry expertise in its staff, and I resent the implication that we have a ‘revolving door’ at the SEC”

Committee Chair: “I am certain that there are many staff attorneys at the SEC who desire to do the right thing. I only question whether they possess effective leadership at the present time, Mr. Clayton.”

Mr. Clayton: “I disagree.”

Flowery languageCommittee Chair:

“So, permit me at this time to summarize what Regulation Best Interest is, or, rather, what it is not. Reg BI imposes little that restricts brokers from engaging in conduct that they engage in currently. There is no actual requirement that brokers avoid significant material conflicts of interest. Nor is there any actual requirement, in the rule, despite the flowery language contained in the release, that brokers properly manage any unavoided conflicts of interest. There is no actual requirement that a brokerage firm, or its brokers, place its customers’ interests before its own. Are these not fair statements about your proposed Reg BI, Mr. Clayton.”

Mr. Clayton: “But I do believe that Regulation Best Interest will raise the standards of conduct of brokers.”

Committee Chair:

“But not substantively, Mr. Clayton, as we have just observed in our review of the actual language of the proposed rule. Very little if any restrictions on broker’s conduct will exist, beyond the weak restrictions found under the current suitability rule. In fact, Reg BI seeks to redefine the term ‘best interests’ and its accepted meaning in the law and in the English language. Much the same as the SEC redefined what ‘solely incidental’ means over the past several decades, in order to accommodate brokers who migrated away from investment product sales and toward giving investment advice.”

Mr. Clayton:Mr. Clayton: “I do not agree with that characterization, Madam Chair.”

Committee Chair:

“Is not Regulation Best Interest, which originated from broker-dealer lobbying organizations, and which proposals were subsequently endorsed in large part by FINRA – the broker-dealer ‘self-regulatory organization’ – and which was subsequently pushed through at the SEC by industry lobbyists as well as those insiders with deep ties to Wall Street – just a means to misrepresent to the American people the true nature of the obligations of broker-dealers to their customers?”

Mr. Clayton: “I do not concur with your assessment.”

Committee Chair:

“Mr. Clayton, does not Regulation Best Interests create the mere illusion that brokers act in the best interests of their customers, in essence as acting under a fiduciary duty of loyalty, when in fact such is not the case?”

Mr. Clayton: “I don’t agree.”

Short-armingCommittee Chair: “Chair Clayton, did not the SEC, it 1940, in its Seventh Annual Report, state at one time: ‘the necessity for a transaction to be really at arm's-length in order to escape fiduciary obligations, has been well stated by the United States Court of Appeals … ‘[T]he old line should be held fast which marks off the obligation of confidence and conscience from the temptation induced by self-interest.

He who would deal at arm's length must stand at arm's length. And he must do so openly as an adversary, not disguised as confidant and protector. He cannot commingle his trusteeship with merchandizing on his own account ….”

Mr. Clayton: “I am not aware of the language from that Report.”

Committee Chair: “Then perhaps you will be aware of a more recent 1963 Study of the Securities Industry by the SEC, what stated that the U.S. Securities and Exchange Commission ‘has held that

where a relationship of trust and confidence has been developed between a broker-dealer and his customer so that the customer relies on his advice, a fiduciary relationship exists, imposing a particular duty to act in the customer’s best interests and to disclose any interest the broker-dealer may have in transactions he effects for his customer … [broker-dealer advertising] may create an atmosphere of trust and confidence, encouraging full reliance on broker-dealers and their registered representatives as professional advisers in situations where such reliance is not merited, and obscuring the merchandising aspects of the retail securities business ….”

Committee Chair: “So, Mr. Clayton, let me refer to something you should recall. In your testimony to the U.S. Congress in December, 2018, when you stated, ‘Simply put, under proposed Regulation Best Interest, a broker-dealer cannot put her or his interests ahead of the retail customer’s interests.’ Yet, as we have established here today, the term ‘best interests’ has an established meaning, in that it equates to the fiduciary duty of loyalty. And, as we have seen, Reg BI, with its safe harbor, does not actually require much above what the low suitability standard requires currently. Reg BI does not require that a broker’s interest be subordinate to that of the customer. Given such, then your testimony to the U.S. Congress has been false, and this proposed Regulation Best Interests is nothing but ‘Reg Bull $&*!’ in reality.

“Then, SEC Chairman Clayton, I suggest that you reject truth, as you don’t appear to know the difference between ‘true’ and ‘false.’ Instead, you seek to make what is ‘false’ become ‘true’ by changing the English language. I further suggest to you that the SEC, once heralded as one of the most effective of government agencies, is in danger under your lack of effective leadership of falling into a dark hole. The SEC in recent decades has become the least effective of our government agencies, and apparently the SEC has now been captured by the very industry it regulates. Perhaps the SEC should be dismantled, and its regulation of market conduct transferred to a new, better agency. But, consideration of that issue is for another time. For now, the SEC appears to be aiding and abetting a massive securities fraud upon the American people. It is that plain. It is that simple. It is that undeniable. This hearing is in recess.”

Ron A. Rhoades, JD, CFP® is the Director of the Personal Financial Planning Program at Western Kentucky University’s Gordon Ford College of Business. A professor of finance, tax and estate planning attorney, investment adviser, and Certified Financial Planner™, he has long written about application of fiduciary law as the delivery of financial planning and investment advice. This article represents his personal views, and are not necessarily the views of any institution, organization, nor firm with whom he may be associated. Professor Rhoades’ comment letters regarding Reg BI and Form CRS, which detail legal authority for the statements set forth herein, can be found at the SEC’s web site.

Part one of the Grand Deception (see STAN's GRAND DECEPTION topic in this forum) is to strongly imply, with words, language, and by every implication, that the investment customer is dealing with a trusted professional advisor/adviser, who will guide, protect and watch over the customer's best courses of action and best interests. (BAIT)

Part two of the Grand Deception is to substitute (bait and SWITCH) a broker, dealing representative (agent for the dealer) or salesperson, for the trusted professional fiduciary adviser that the customer thinks they are getting……below is a good summary of the second part of this process, although it carefully avoids one of the greatest elements of the suitability obligation since it is written by industry participants……the deception continues even in this case summary. Missing element will be disclosed at the end of this post.================

The suitability standard is a relatively low standard of investment advice. It merely requires that a recommendation be suitable for an investor given his/her personal circumstances. It does (this should say "does not") have to be the best , lowest risk or best price. The suitability standard stands in contrast to the Best Interests Standard ( referred to as a fiduciary standard) that requires an advisor to act in the best interests of the client. Here is an extract from an MFDA Decision that succinctly articulates the fundamentals of the Suitability standard:“...158. Existing jurisprudence establishes a three-stage process that advisors should follow to meet their suitability obligations. The three-stage process is described by the Alberta Securities Commission in Lamoureux, supra at p. 18:Suitability is to be assessed prior to any investment recommendation by the registrant to a client. The process that culminates in a registrant’s investment recommendation to a client has three component phases or stages that must occur in sequence.The first stage involves the “due diligence” steps undertaken by the registrant to “know the client” and to “know the product”. Knowing the product involves carefully reviewing and understanding the attributes, including associated risks, of the securities that they are considering recommending to their clients. Knowing the client was discussed above. Only after the “due diligence” of the first stage is completed, can the registrant move to the second stage in which they fulfill their obligation to determine whether specific trades or investments, solicited or unsolicited, are suitable for the client.Suitability determinations . . . will always be fact specific. A proper assessment of suitability will generally require consideration of such factors as a client’s income, net worth, risk tolerance, liquid assets and investment objectives, as well as understanding an understanding of particular investment products. The registrant must apply sound professional judgement to the information elicited from “know your client” inquiries. If, based on the due diligence and professional assessment the registrant reasonably concludes that an investment in a particular security in a particular amount would be suitable for a particular client, it is then appropriate for the registrant to recommend the investment to that client.By recommending a securities transaction to a client, a registrant enters the third stage of the process... At this stage, when making the client aware of a potential investment, the registrant is obligated to make the client aware of the negative material factors involved in the transaction, as well￼￼￼￼￼￼1as positive factors. The disclosure of material negative factors in the third stage of the process is intended to assist the client in making an informed investment decision.159. There are several features of the suitability analysis that must be emphasized. These do not purport to be exhaustive, but are all relevant to the issues at this hearing.160. First, an advisor is mandated to know the client, not merely those associated with the client. Information about the experience or sophistication of the client’s relative or friend, absent a power of attorney or similar legal authorization, is not a proxy for knowing the client or obtaining instructions from the client. Of course, a client may enlist friends or family to participate in meeting with an advisor, and in assisting the client in making investment decisions. However, it remains the advisor’s personal responsibility to ensure that an investment is suitable for that client, and that the client (not just a friend or family member) makes an informed decision based on an understanding of the potential downside to the investment. We also observe that it undermines supervisory and compliance safeguards to attribute the personal characteristics of friends or family members to the client in a KYC form161. Second, the completion of a KYC form alone does not insulate advisors from a finding that the first stage of the suitability process has not been performed. The KYC form is merely one tool to facilitate fulfillment of the advisor’s obligation. Of course, a KYC form filled out by or with the involvement of the advisor in a perfunctory, incomplete, or inaccurate way undermines the validity of the suitability analysis. Equally important, the mischaracterization by an advisor of the client’s experience, investment horizon or objectives in a way that is designed to validate an otherwise unsuitable investment recommendation amounts to a serious breach of an advisor’s obligation to act in the client’s best interests. Similarly, the completion of inadequately explained forms such as acknowledgements or waivers does not mean that the advisor has met his or her disclosure obligation. Disclosure must be provided in a meaningful way so that the advisor can competently determine that the client both understands the risks and features of the products and strategies that are being recommended and is making an informed decision to proceed.162. Third, the obligation to assess suitability rests with the advisor, and cannot be assumed only by the client, even where the client is aware of the risks associated with a particular investment or strategy.163. Fourth, without purporting to describe all of the criteria in determining suitability, it can fairly be stated that an investment product or strategy is not suitable for a client unless, at a minimum, the client has the sophistication necessary to understand the relevant risks, the willingness to accept the risks and the capacity to withstand the potential adverse consequences that might result from those risks materializing.164. Fifth, an investment product or strategy is not retroactively made unsuitable because it fails due to circumstances that were not reasonably foreseeable. Conversely, an advisor is expected to disclose to the client, at a minimum, reasonably foreseeable adverse conditions or risks that are material to an investment decision. An advisor’s belief that such reasonably foreseeable conditions or risks are unlikely to materialize does not relieve the advisor from this disclosure obligation. In this regard, we adopt with approval, the observations of the British Columbia Court of Appeal in Rhoads v. Prudential- Bache Securities Canada Ltd., [1992] B.C.J. No. 153 at p.8:￼￼￼￼￼￼￼￼￼￼￼￼￼￼2It ought to be reasonably foreseeable to any investment advisor that there might,at almost any time, be a market downturn that might prove to be of minor or major proportion and would impact, potentially substantially, the performance of an equity based mutual fund. Even though the precise timing of a downturn may not be predictable, the possibility of a downturn at any time is foreseeable. However, such an event would not necessarily be foreseeable to an investor.165. Sixth, special considerations apply if a leveraged strategy is contemplated. As Staff accurately reflected at paragraph 69 of its written submissions, an advisor who is evaluating the suitability of a leveraged strategy must consider whether:(a) the client has sufficient income or unencumbered liquid assets to be able to:(i) withstand a market downturn without jeopardizing their financial security (including their ability to maintain their home);(ii) meet a margin call (if potentially applicable); and(iii) satisfy all loan obligations (both principal and interest) associated with the strategy without relying on anticipated income from the investments; and(b) there is any reason to expect the client’s current sources of income to be reduced in the short term bearing in mind the client’s stage of life (age, anticipated retirement date, etc.), employment status and personal circumstances (e.g.; disability, pregnancy,any known risk of imminent anticipated job loss, etc.).Stage three of the suitability analysis is of particular importance when a leveraged strategy is being recommended. The advisor must properly explain and ensure that the client understands how the investment product, including leveraging, works and the material risks associated with the implementation of the proposed strategy. This is simply a reflection of an advisor’s obligation to disclose to a client in relation to any investment product or strategy, the benefits and potential risks in a balanced, realistic and objective way. An advisor’s assessment of risk cannot be skewed by the advisor’s optimism in the strategy or by self-interest.166. Seventh, the duty on an advisor to take positive steps to ensure that the recommendation is suitable and that adequate disclosure of the risks has been made is of particular importance where the client has limited investment experience or lacks financial sophistication.167. Finally, an advisor is not entitled to make an unsuitable recommendation even if he or she discloses material negative factors about the product or strategy and regardless of whether the client claims to understand and accept the risks involved in the investment. It is unnecessary for us to address the situation in which an advisor is asked to implement a strategy against his or her recommendations since the Respondent does not allege that this scenario ever arose here.The “Fair Dealing” Rule168. In addition to the MFDA Rule governing unsuitability, MFDA Rule 2.1.1 (sometimes described as the “fair dealing” rule) is relevant to the allegations contained in the Amended Notice of Hearing. It articulates the standard of conduct imposed upon all Members and Approved Persons. It requires, among other things, that Members and Approved Persons:(a) deal fairly, honestly and in good faith with clients;(b) observe high standards of ethics and conduct in the transaction of business; (c) refrain from engaging in business conduct or practice which is unbecoming or￼￼￼￼￼￼￼￼￼￼3detrimental to the public interest; and(d) be of such character and business repute and have such experience and training as is consistent with the standards of the industry. ...”These basic principles are too often ignored when dealers provide their so-called Substantive Reponse to complainants. This why we continue to press regulators for reforms of the KYC process, enhanced risk profiling and better supervisory controls.Kenmar Associates

Now for the most important element missing in the "suitability test". It is a measurement, comparison and customer informed evaluation of the COSTS of various investment recommendations. This is the essential part of the Grand Deception where the PAYOFF comes to the dealer/advisor. After fooling their customers into a false sense of trust, then substituting a commission salesperson instead of a fiduciary……the win for the dealer/salesperson is to then sell products which are to the greatest advantage to the dealer and not the customer. The difference is in the hundreds of billions silently transferred from the pockets of investors, into pockets of dealers.

See video on the suitability standard, from a recovering broker, who tells how it is a license to steal from clients rightful returns: http://youtu.be/aWulI3Kwi_A

1. There are two vastly differing standards of care for “advisors” who deal with investors:

(1) first is the fiduciary standard of care, which is roughly equivalent to a medical “do no harm” oath for investors.(2) second is the suitability standard, which is suitably vague, subjective, self assessed by the seller, and allows investment dealers to sell the LEAST suitable of investment choices to investors and still meet this subjective standard.

The source of references for this point can be found at the Canadian Securities Administrators (CSA) where it is fairly difficult to uncover, and the SEC, where it is well disclosed. See 88 words from SEC Chair Mary Jo White in under two minutes on this subject at http://youtu.be/TqBSiR6VwP4

2. The fiduciary standard of care is usually, but not always given by those persons who are duly licensed in the category of “adviser”, and this (adviser) is often found spelled in various legislation with an “e”. (ie Investment Adviser's Act of 1934, 1940, etc., USA, Securities Acts in 13 Provinces, Canada)

3. The “suitability” standard is most often applied to persons who in the US are licensed in the legal category called “broker”, and in Canada, the legal license category is “dealing representative”. Dealing representative was, until 2009, the category titled “salesperson”, when the name was changed to dealing representative. (All reference to the word "salesperson" were deleted from Securities Acts in 13 Canadian jurisdictions in Sept 2009)

4. Persons referring to themselves as “advisor” are usually not licensed in either the “adviser” license category or a non-existent “advisor” license category. It is claimed by some regulators to be a non-legal, non registration "title" and by others to be a virtually identical term as “adviser” with an “e”.

Some regulators and experts say it is a separate and distinct term, while others, including some journalists and experts see no difference in the two spellings. These "dictionary" debates have three very large holes in them, and are also NOT the important point.

The POINT is whether consumers are being served by persons with a “do no harm” type of fiduciary duty, or a undefinable term like “suitability”

. The major secondary point is

whether consumers are being intentionally deceived

by spelling tricks, in order to pass one off as the other. Would the investment industry (and regulators) truly do this, and what would be their motivation?

5. The rather large holes mentioned in #4 above are this: IF the terms “advisor” and “adviser” are virtual “twins”, useable interchangeably for each other........THEN approximately 750,000 investment salespersons in the US and Canada are intentionally deceiving consumers into a false belief that they are licensed and registered as fiduciary “advisers”. This is a deceit tantamount to fraud, since those persons with a "broker" or dealing rep license have no right to tell customers that they are licensed as advisor or adviser. Neither is true.

( Additionally, as Stan points out, "If Advisor is same as Adviser they should have same legal responsibility shoudn't they?" )

IF, on the other hand, the two words carry different meanings, then those persons referring to themselves as “advisors”, while there is no legal license category for such a word, spelled in such a manner......are deceiving the public by

simply trying to pass off a spelling trick as an implied professional license

. This does not meet with securities laws, rules and policies, just two of which are shown below in point #6.

The third hole in the "dictionary debate" is that billions and billions of dollars can be documented as being shortchanged from investors, by industry persons who are misleading and deceiving customers by hiding the true license and duty of care categories. This goes well beyond playing dictionary games, and may in fact be

one of the greatest hidden risks facing an investor today

.

6. (from section 34 of the BC Securities Act)

Persons who must be registered

34 A person must not(a) trade in a security or exchange contract,(b) act as an adviser,(c) act as an investment fund manager, or(d) act as an underwriter,unless the person is registered in accordance with the regulations and in the category prescribed for the purpose of the activity.http://www.bclaws.ca/Recon/document/ID/ ... #section34

and this from the MFDA (Mutual Fund Dealers Association of Canada)

The MFDA rule 1.21(d) prohibits MFDA members from using any business name or designation that deceives or misleads as to their proficiency qualifications.

IIROC and other securities regulators have similar rules, codes and laws against misrepresentation, either by commission or by omission. It occurs that when licensed persons refuse to disclose the true license category of their registration, and hide the “suitability” verses “fiduciary” differences involved, that there is a grand deception. It certainly fails the IIROC industry requirement to deal honestly, fairly and in good faith with the public.

7. Lastly: From “Understanding Misleading Financial Advisor Titles – Your Right to Know” Bryon C. Binkholder"Anything else is fraud, because the seller is delivering a service different from what the consumer thinks he or she is buying. " Edward Waitzer article, Financial Post · Tuesday, Feb. 15, 2011) (Mr. Waitzer is a Bay Street Lawyer and former Securities Commission chair, and this quote ( by another person) appeared in his article.

Financial Advisor Chicanery: Imagine a two-tiered health care system in which some doctors were legally obligated to do what's right for their patients and others, like snake-oil salesmen of yore, could recommend whatever treatments made them the most money, as long as they didn't kill patients outright. Now imagine that the shysters did all they could to blend in with the real doctors. That's effectively the type of system we have today among the people Americans count on to tell them how to invest their life's savings. Registered investment advisors must, by law, put clients' interests first. Many thousands of other "advisors" at places like Morgan Stanley, Merrill Lynch and smaller shops are held to a much lower "suitability" standard. In essence, even though these people often refer to themselves as "financial advisors" or by some other comfort-inducing title, they're really glorified salesmen. Some do a great job serving their clients. Others don't. It's up to them. Under the law, as long as they avoid putting an 85-year-old widow into an exotic derivative with a 20-year lockup, they're bulletproof. Few clients know this fiduciary-suitability gap exists. The suitability crowd has worked tirelessly to keep the standard low and the distinctions murky. The cost to the public is incalculable but huge.

IF YOU HAVE SUFFERED LOSSES AT THE HANDS OF SOMEONE CLAIMING TO BE AN "ADVISOR" I HOPE YOU WILL TRIPLE CHECK THEIR ACTUAL LICENSE< WATCH THIS VIDEO< AND TALK TO A CLASS ACTION LAWYER ABOUT GETTING YOUR MONEY BACK http://youtu.be/KH6XMXlfdBw

Thank you for contacting the U.S. Securities and Exchange Commission (SEC) concerning the SEC's recent formation of the Investor Advisory Committee. You urge the SEC to establish clear policies that would assist the public in understanding the differences between when is advice given by investment advisers and broker-dealers.

The SEC’s Office of Investor Education and Advocacy processes many comments from individual investors and others. We keep records of the correspondence we receive in a searchable database that SEC staff may make use of in inspections, examinations, and investigations. In addition, some of the correspondence we receive is referred to other SEC offices and divisions for their review. If they have any questions or wish to respond directly to your comments, they will contact you.

• Both broker-dealers and investment advisers play an important role in helping Americans organize their financial lives, accumulate and manage retirement savings, and invest toward other important long-term goals, such as buying a house or funding a child’s college education.• When the federal securities laws were enacted, Congress drew a distinction between broker-dealers, who were regulated as salespeople under the Securities Exchange Act of 1934, and investment advisers, who were regulated as advisers under the Investment Advisers Act of 1940.

• Over the last several decades, however, the roles of some broker-dealers and investment advisers have converged. While differences remain, many broker-dealers today offer advisory services, such as investment planning and retirement planning, that are similar to the services offered by investment advisers. In addition, many broker-dealers use titles such as financial adviser for their registered representatives and market themselves in ways that highlight the advisory aspect of their services.

• Because federal regulations have not kept pace with changes in business practice, broker- dealers and investment advisers are subject to different legal standards when they offer advisory services. Those legal standards – a suitability standard for broker-dealers and a fiduciary duty for investment advisers – afford different levels of protection to the investors who rely on those services. Key differences include the requirements that investment advisers, as fiduciaries, act in the best interests of their clients and appropriately manage and fully disclose conflicts of interest that could bias their recommendations.

• Investors typically make no distinction between broker-dealers and investment advisers, and most are unaware of the different legal standards that apply to their advice and recommendations. Although many investors don’t understand the meaning of “fiduciary duty,” or know whether it or suitability represents the higher standard, investors generally treat their relationships with both broker-dealers and investment advisers as relationships of trust and expect that the recommendations they receive will be in their best interests.

• Investors may be harmed if they choose a financial adviser under a mistaken belief that the financial adviser is required to act in their best interest when that is not the case, receive recommendations that comply with a suitability standard but carry additional costs or risks without affording additional benefits, or fail to receive the on-going account supervision that they expect based on the manner in which brokers’ advisory services are sometimes marketed.

• Although they are more subtle and more difficult to measure than the harm that results from outright fraud, these types of harm can nonetheless have a significant impact on investors’ financial well-being. Despite the difficulty of quantification, the Committee believes it is essential that the economic analysis currently being undertaken by the Commission acknowledge both the existence and importance of investor harms of this type that can result from advice delivered under a suitability standard.

Recommendations

The Investor Advisory Committee believes that personalized investment advice to retail customers should be governed by a fiduciary duty, regardless of whether that advice is provided by an investment adviser or a broker-dealer.1 The Committee further believes that the fiduciary duty for investment advice should include, first and foremost, an enforceable, principles-based obligation to act in the best interest of the customer. In approaching this issue, the SEC’s goal should be to eliminate the regulatory gap that allows broker-dealers to offer investment advice without being subject to the same fiduciary duty as other investment advisers but not to eliminate the ability of broker-dealers to offer transaction-specific advice compensated through transaction-based payments. Though it may require both regulatory flexibility to permit the existence of conflicts of interest and some regulatory changes to reduce the most severe conflicts of interest in the broker-dealer business model, the Committee believes that advisory services offered as part of a transaction-based securities business can and should be conducted in a way that is consistent with a fiduciary standard of conduct.

Recommendation 1The Commission should conduct a rulemaking to impose a fiduciary duty on broker- dealers when they provide personalized investment advice to retail investors.A. The Committee favors an approach that involves rulemaking under the Investment Advisers Act to narrow the broker-dealer exclusion from the Act while providing a safe harbor for brokers who do not engage in broader investment advisory services or hold themselves out as providing such services.B. Atthesametime,theCommitteerecognizesthattheCommissionisconsidering rulemaking under Section 913(g) of the Dodd-Frank Act. Should the Commission choose to conduct rulemaking under Section 913, the Committee supports the following approach:a. In order to ensure that the standard is no weaker than the existing Advisers Act standard, any fiduciary rule adopted must incorporate an enforceable, principles-based obligation to act in the best interests of the customer.1 While this recommendation deals specifically with advice to retail customers, the Committee notes that Dodd- Frank authorizes the SEC to extend fiduciary protections to other vulnerable market participants. The Commission should consider whether action beyond the retail arena is needed and appropriate.￼￼b. In order to ensure the continued availability of transaction-based recommendations, any standard adopted should be sufficiently flexible to permit the existence of certain sales-related conflicts of interest, subject to a requirement that any such conflicts be fully disclosed and appropriately managed.c. While recognizing that some forms of transaction-based payments would be acceptable under a fiduciary standard, the Commission should fulfill its Dodd- Frank mandate to “examine and, where appropriate, promulgate rules prohibiting or restricting certain sales practices, conflicts of interest, and compensation schemes for brokers, dealers, and investment advisers that the Commission deems contrary to the public interest and the protection of investors.”Supporting Rationale:The Commission should conduct a rulemaking to impose a fiduciary duty on broker- dealers when they provide personalized investment advice to retail investors.A broad consensus exists among widely disparate groups (representing investors, state securities regulators, investment advisers, and broker-dealers) that broker-dealers and investment advisers should be subject to a uniform fiduciary standard when they provide personalized investment advice to retail investors. In a recent letter to the Commission, the Securities Industry Financial Markets Association stated, for example, that it “has long supported a uniform fiduciary standard for BDs and RIAs when providing personalized investment advice about securities to retail clients.”2 Meanwhile, organizations such as the North American Securities Administrators Association (NASAA), Consumer Federation of America (CFA), AARP, Fund Democracy and the various investment adviser/financial planning groups have been calling for enhanced fiduciary protections for the advisory clients of broker-dealers for two decades or more. Adoption of a uniform fiduciary standard was also the recommendation of the SEC staff in its 913 Study.3Rather than opposing fiduciary rulemaking, the leading broker-dealer trade associations have sought to ensure that any rules adopted provide sufficient clarity regarding their regulatory obligations and continue to permit them to offer traditional, transaction-based brokerage2 July 5, 2013 letter from Ira D. Hammerman, Senior Managing Director and General Counsel, SIFMA, to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, available here: http://www.sec.gov/comments/4- 606/4606-3128.pdf. See also, July 5, 2013 letter from David T. Bellaire, Executive Vice President and General Counsel, Financial Services Institute to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, (available here: http://www.sec.gov/comments/4-606/4606-3138.pdf), which listed a uniform fiduciary standard as one component of a regulatory approach that can provide “widespread benefits to all stakeholders.”3 SEC Staff, Study on Investment Advisers and Broker-Dealers, As Required by Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, January 2011 (available here: http://www.sec.gov/news/studies/2011/913studyfinal.pdf).￼￼￼￼￼￼services.4 While there are disagreements among the various stakeholder groups over some important implementation issues, there is general agreement that the Commission should adopt a regulatory approach that preserves the ability of brokers to offer transaction-specific recommendations compensated through transaction-based payments.5 In keeping with this goal, the various stakeholder groups also generally agree that the fiduciary duty should not apply to all brokerage services, but only to those services that fall within a reasonable definition of personalized investment advice to retail customers. The Committee shares these views.The limited opposition that exists to rulemaking in this area is based first on the argument that broker-dealers are already extensively regulated under existing state and federal laws and self-regulatory organization rules. While this is true, it is largely irrelevant to the question of what standard should apply when broker-dealers provide personalized investment advice to retail customers. Put another way, the question is not whether broker-dealers are adequately regulated when they act as salespeople but whether they are adequately regulated when they act as advisers. In the view of the Committee, the existing securities regulatory scheme that treat broker-dealers as salespeople does not offer adequate investor protection when broker-dealers offer advisory services, since under a suitability standard they generally remain free to put their own interests ahead of those of their customers. As SIFMA stated in its recent comment letter to the SEC, “a uniform fiduciary standard would result in a heightened focus on serving the best interests of retail clients.”Some others have suggested that regulation is not needed because investors are capable of choosing for themselves whether they prefer to work with a broker-dealer operating under a suitability standard or an investment adviser who is a fiduciary. This might have been true if the Commission had over the past several decades adopted a regulatory approach that maintained a bright line between broker-dealers and investment advisers. But that has long since ceased to be the case. As the RAND Study,6 the SEC’s recent financial literacy study,7 and numerous outside surveys have all documented, investors today do not have the tools to make an informed choice. Specifically, investors do not distinguish between broker-dealers and investment advisers, do not know that broker-dealers and investment advisers are subject to different legal standards, do not understand the differences between a suitability standard and a fiduciary duty, and expect broker- dealers and investment advisers alike to act in their best interests when giving advice and making recommendations. This is the natural result of regulatory policy that has allowed brokers to rebrand themselves as advisers without being regulated as advisers.4 See, for example, the July 14, 2011 letter from Ira D. Hammerman, SIFMA Senior Managing Director and General Counsel, to SEC Chairman Mary Schapiro regarding a “Framework for Rulemaking under Section 913 (Fiduciary Duty) of the Dodd-Frank Act” (File No. 4-604).5 See, for example, March 28, 2012 letter from CFA, Fund Democracy, AARP, Certified Financial Planner Board of Standards, Inc., Financial Planning Association, Investment Adviser Association, and National Association of Personal Financial Advisors to SEC Chairman Mary Schapiro (available here: http://www.sec.gov/comments/4- 606/4606-2973.pdf), which provides a framework for rulemaking that seeks to enhance investor protection without sacrificing investor choice.6 Hung, Angela A. et al, Technical Report: Investor and Industry Perspectives on Investment Advisers and Broker- Dealers, sponsored by the U.S. Securities and Exchange Commission, RAND Institute for Civil Justice, 2008 (available here: http://www.sec.gov/news/press/2008/2008 ... report.pdf).7 Staff of the Securities and Exchange Commission, Study Regarding Financial Literacy Among Investors (As Required by Section 917 of the Dodd-Frank Wall Street Reform and Consumer Protection Act), August 2012.￼￼￼￼In light of the evidence that the blurring of the lines between broker-dealers and investment advisers has made it difficult, if not impossible, for typical retail investors to make an informed choice between broker-dealers and investment advisers, the Committee believes that a regulatory solution that reduces the potential for investor harm is necessary. As the SEC staff stated in the 913 Study, “Retail investors are relying on their financial professional to assist them with some of the most important decisions of their lives. Investors have a reasonable expectation that the advice that they are receiving is in their best interest. They should not have to parse through legal distinctions to determine whether the advice they receive was provided in accordance with their expectations.”The Commission has a range of options available to it for achieving this regulatory goal. These include the approach recommended in Section 913(g) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. But the Commission also has other grounds for action, including existing authority under the Investment Advisers Act to regulate non-incidental advice by broker-dealers. In deciding on the optimal regulatory approach, the Commission should weigh its various options with an eye toward determining which will best ensure an outcome that strengthens investor protections, preserves investor choice with regard to business models and compensation methods, and is workable for broker-dealers and investment advisers alike.A. The Committee favors an approach that involves rulemaking under the Investment Advisers Act to narrow the broker-dealer exclusion from the Act while providing a safe harbor for brokers who do not engage in broader investment advisory services or hold themselves out as providing such services.The Committee believes that the dual goals of strengthening investor protections while preserving investor choice could best be achieved through rulemaking under the Advisers Act. By significantly narrowing of the broker-dealer exclusion from the Investment Advisers Act, such an approach would restore the functional regulation intended by Congress when it adopted the ’34 and ’40 Acts. Under such an approach, broker-dealers who choose to offer personalized investment advice to retail investors, such as retirement planning or investment planning, that goes beyond the buy/sell recommendations inherent to securities transactions would be regulated in the same fashion as other investment advisers when they engage in those advisory activities.8 Broker-dealers who “hold themselves out” as advisers, based either on the titles they use or the manner in which they market their services, would be precluded from relying on the exclusion. (This is consistent with the approach the Commission adopted with regard to accountants and attorneys when it was first interpreting how the Advisers Act applied to those professionals who held themselves out as financial planners.)9One significant benefit of such an approach is that it would provide a firm assurance that the fiduciary standard for investment advice by broker-dealers and investment advisers would be the same and would be no weaker than the existing standard. It would, for example, ensure that the existing legal precedent, staff interpretations, and no-action positions developed under the8 The Commission would still need to define what activities by broker-dealers constitute investment advice subject to regulation under the Advisers Act and which do not. Non-advisory activities by these broker-dealers would continue to be regulated under the Securities Exchange Act.9 See, for example, SEC Investment Advisers Act Rel. No. 770 (1981) as well as SEC Rel. No. IA-1092 (1987).￼Advisers Act and accompanying rules would also apply to investment advice by brokers. And it would achieve this without the necessity of creating a whole new parallel body of law under the ’34 Act. To the degree that specific aspects of that existing body of Advisers Act law and interpretation would need to be amended or revised for the purpose of applying it to the broker- dealer business model, that could be accomplished through adoption of appropriate rules and guidance under the Advisers Act.10Under this approach, there would be minimal risk that existing investor protections would be weakened as a result of efforts to accommodate the broker-dealer business model. Under such an approach, broker-dealers who wish to avoid regulation under the Advisers Act could do so by limiting themselves to transaction-specific recommendations while avoiding holding themselves out as advisers or as providing advisory services. In order to ensure clear communication to investors, it may also be necessary for the Commission to require some sort of affirmative disclosure in such circumstances to the effect that the broker-dealer is acting solely as a salesperson and not as an objective adviser. Broker-dealers who complied with these conditions would in effect have a safe harbor from Advisers Act regulation.Brokerage firms would then face a clear business decision: do the benefits of offering advisory services and marketing themselves accordingly outweigh the costs of regulation under the Advisers Act? Faced with a similar decision when the courts determined that fee-based accounts were advisory accounts, most broker-dealers chose to accept regulation under the Advisers Act. We believe the outcome would be similar in this instance. But investors would also benefit even if certain broker-dealers chose to avoid Advisers Act regulation if the result was that those broker-dealers stopped characterizing their services as advisory services when making recommendations that are not required to promote the best interests of the customer. Thus, this approach would also preserve investors’ ability to choose to receive transaction-based advice subject to a fiduciary duty or non-advisory transaction-based services subject to a suitability standard, and their ability to distinguish between those different types of services would be enhanced.B. At the same time, the Committee recognizes that the Commission is considering rulemaking under Section 913(g) of the Dodd-Frank Act. Should the Commission choose to conduct rulemaking under Section 913, the Committee supports the following approach:a. In order to ensure that the standard is no weaker than the existing Advisers Act standard, any fiduciary rule adopted must incorporate an enforceable, principles-based obligation to act in the best interests of the customer.10 This is the approach that the Commission has taken in the wake of the court decision requiring all fee-based accounts to be regulated as advisory accounts. Without taking a position on the temporary principal trading rules adopted by the Commission in the wake of that decision, the Committee believes this show the feasibility of providing targeted carve-outs for broker-dealers from Investment Advisers Act rules that are incompatible with the broker-dealer business model. The goal in devising any such carve-outs should be to ensure that the best interests of the customer are protected.￼b. In order to ensure the continued availability of transaction-based recommendations, any standard adopted should be sufficiently flexible to permit the existence of certain sales-related conflicts of interest, subject to a requirement that any such conflicts be fully disclosed and appropriately managed.c. While recognizing that some forms of transaction-based payments would be acceptable under a fiduciary standard, the Commission should fulfill its Dodd-Frank mandate to “examine and, where appropriate, promulgate rules prohibiting or restricting certain sales practices, conflicts of interest, and compensation schemes for brokers, dealers, and investment advisers that the Commission deems contrary to the public interest and the protection of investors.”The Committee recognizes that, since passage of the Dodd-Frank Act, much of the impetus behind fiduciary rulemaking has had as its source the authorizing language contained in Section 913(g) of that act. In insisting that the fiduciary standard be the same for broker-dealers and investment advisers and no weaker than the existing Advisers Act standard, Section 913 provides an appropriate basis for rulemaking. Importantly, it recognizes that a fiduciary duty that is identical in principle is, because of its facts-and-circumstances-based application, flexible enough to be applied differently in different circumstances and to different business models. This is key to developing an approach that strengthens investor protections without unduly limiting investor choice.However, the statutory language of Section 913 poses some significant implementation challenges as well. Specifically, it includes provisions specifying that certain prevalent broker- dealer business practices – such as earning commissions, selling proprietary products, and selling from a limited menu of products – should not automatically be deemed to constitute a violation of the fiduciary standard. It intentionally avoids applying Advisers Act provisions with regard to principal trades to brokers, but without specifying how principal trades by brokers should be regulated under a fiduciary standard. And it specifies that brokers would not have an on-going duty of care “after” the advice is rendered. Depending on how certain of these provisions are interpreted and enforced – particularly those with regard to selling from a limited menu of products and the on-going duty of care – such an approach could result in a significant weakening of the existing Advisers Act standard.We encourage the Commission to arrive at a rule based on Section 913 that is strong and effective, but it is also possible that rulemaking under Section 913 could weaken protections for investors who receive advice from investment advisers without providing meaningful improvement in protections for those who invest through broker-dealers. For example, if the Commission were to interpret Section 913 as permitting sale from a menu of products so limited as to preclude any recommendation from that menu’s being in the best interests of the customer, that would leave unchallenged some of the most troubling practices permitted under the suitability standard. Similarly, if the Commission were to interpret Section 913 as permitting broker-dealers to switch in and out of a fiduciary duty even where there is an on-going relationship with that client and an implication of ongoing account management, such anapproach could leave investors more confused than ever and at greater risk of being misled. 11 Furthermore, Section 913 anticipates that the Commission would undertake parallel rulemaking under both the Investment Advisers Act and the ’34 Act and produce rules that are the same for broker-dealers and investment advisers. Because new rules would supersede past interpretation of the Advisers Act standard, any weaknesses in the rules adopted in order to accommodate the broker-dealer business model and the specific directives in the Section 913 statutory language would have a spill-over effect, weakening existing protections under the Advisers Act for clients of investment advisers. The Committee would strongly oppose such a result and urges the Commission to avoid this outcome at all costs.In order to do so, the Commission must include, in its definition of fiduciary duty, an enforceable principles-based obligation to act in the best interests of the customer. This is consistent with the statutory language of Section 913(g), which authorizes the Commission to “promulgate rules to provide that the standard of conduct for all brokers, dealers, and investment advisers, when providing personalized investment advice about securities to retail customers (and such other customers as the Commission may by rule provide), shall be to act in the best interest of the customer without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice.” Such an interpretation is also consistent with the recommendation of the SEC staff in its 913 Study, which notes that an important distinction between the fiduciary duty and suitability standard is the inclusion in the fiduciary duty of an obligation to act in the best interests of clients.The Committee believes this legislative mandate can be achieved through a fiduciary rule that requires all those who provide personalized investment advice to retail investors to have a reasonable basis for believing their recommendations are in the best interest of the customer. In addition to performing the analysis necessary to determine the customer’s best interest (comparable to the current know-your-customer obligations), those providing investment advice should be required to document the basis for their belief that their recommendation is in the customer’s best interests. Such an approach would not require broker-dealers to avoid all conflicts of interest. But it would require them to attempt to act in their customers’ best interests despite their conflicts of interest, put policies and procedures in place to better ensure compliance, and hold them accountable when they fail to do so.Both SIFMA and FSI have voiced support for a fiduciary standard that includes a best interest obligation. Their key concern has been to ensure that they have adequate guidance before a rule is finalized for how that standard would be applied in the context of the broker- dealer business model. The Committee agrees that brokers and investors alike will be best served if brokers understand their obligations under a new fiduciary standard. In the Committee’s view, however, it would be a mistake to try to spell out every aspect of a broker’s fiduciary obligations through rules. Instead, the Commission should adopt guidance before the11 The Committee believes that it is important that an ongoing fiduciary duty apply in circumstances in which broker-dealers hold themselves out in ways that imply they are providing ongoing account oversight and management. Thus, the ongoing duty of care would not apply to all brokerage services, but only in those instances in which a reasonable expectation of ongoing advice had been created. If the Commission were to proceed with rulemaking under Section 913, it would be important that it interpret the provision regarding ongoing duty of care in a way that is consistent with this principle.￼rule is implemented to help clarify how the fiduciary duty in general and the best interest obligation in particular would apply in the context of the transaction-based broker-dealer business model. The guidance should cover the key issues brokers are likely to face in adapting to the new standard. While avoiding an overly prescriptive rules-based approach, the Commission should supplement that guidance by adopting supporting rules in areas such as disclosure obligations where more specific standards are needed. Such an approach would provide the clarity that brokers need while preserving the flexibility of the fiduciary duty as a facts-and-circumstances-based standard.Another way to ensure that the rule is compatible with the broker-dealer business model is for the Commission to adopt a regulatory approach that permits the existence of certain sales- related conflicts of interest while requiring that any such conflicts be disclosed and appropriately managed. Toward that end, we recommend that the Commission adopt a rule that requires broker-dealers and investment advisers who provide personalized investment advice to retail customers: to identify any material conflicts of interest that a reasonable investor would view as compromising their ability to act in the customer’s best interest; to develop a plan for appropriately managing those conflicts to ensure that the best interests of the customer prevail; to have policies and procedures in place designed to ensure that the individuals providing the advice have a reasonable basis for believing their recommendations are in the best interest of the customer and document the basis on which they reached that conclusion; and to monitor compliance. Such an approach should preserve the ability of broker-dealers to receive transaction-based compensation and preserve this option for customers who prefer to receive transaction-based advice.At the same time, the Dodd-Frank Act requires the Commission to “examine and, where appropriate, promulgate rules prohibiting or restricting certain sales practices, conflicts of interest, and compensation schemes for brokers, dealers, and investment advisers that the Commission deems contrary to the public interest and the protection of investors.” We believe it is of important for the Commission to conduct this analysis both as part of its fiduciary rulemaking and as an ongoing aspect of its market oversight. Where it finds practices that are clearly inconsistent with a broker-dealer or investment adviser’s fiduciary obligations and that cannot be appropriately managed through other means, it has an obligation to act through rulemaking to limit or ban those practices. As previously discussed, outright prohibitions would not be appropriate in instances where conflicts can be managed through other means and where the provider of the investment advice can document a reasonable basis for believing recommendations are in the best interest of the customer.Recommendation 2As part of its rulemaking, the Commission should adopt a uniform, plain English disclosure document to be provided to customers and potential customers of broker-dealers and investment advisers at the start of the engagement, and periodically thereafter, that covers basic information about the nature of services offered, fees and compensation, conflicts of interest, and disciplinary record.Supporting Rationale:￼￼The Committee does not believe that disclosure alone is sufficient to address the harm that can result when broker-dealers are free to offer “advice” that puts their own interests of ahead of the interests of their customers. On the other hand, we do believe that improved disclosure should be included as part of any fiduciary rulemaking. One area needing improvement is the disclosure investors receive to help them select a financial professional. While investment advisers are required to provide pre-engagement disclosure to all prospective clients, broker-dealers are not subject to a comparable requirement.We believe investors would benefit from receiving uniform, plain English disclosure documents from broker-dealers and investment advisers covering key factors that are relevant to the selection of an investment professional.12 Relevant topics might include: What services do you provide? What and how do I pay? How are you compensated? What are your conflicts of interest? Are there other limitations on your services? What is your professional background? Are there any blemishes on your disciplinary record? And, particularly if the Commission fails to adopt a uniform fiduciary standard, what is your legal obligation to me?The ADV form that investment advisers use to disclose to their clients provides a reasonable starting point for designing such a document. However, we encourage the Commission to continue to review the ADV form to determine whether it could be further refined to make it a more user-friendly document. The results of the SEC’s recent financial literacy study suggest that additional work may be needed to improve investors’ ability to make good use of disclosed information whose significance they struggle to comprehend. Among other things, we encourage the Commission to develop an approach to disclosure of disciplinary record that makes it easier for investors to assess the significance of disclosed events, particularly for firms that may have a large number of relatively insignificant technical violations. As part of that analysis, the Commission should look at whether it might be beneficial to adopt a layered approach to such disclosures, with the goal of developing a more abbreviated, user-friendly document for distribution to investors. In general, we would encourage the Commission to work with disclosure design experts to ensure that any document it develops is effective in conveying the relevant information to investors in a way that enables them to act on that information.￼12 While the content of the disclosures would vary to reflect differences in the businesses of broker-dealers and investment advisers, the topics covered, format, and presentation of the information should, to the degree possible, be consistent.

The insight in this post was a biblical reference, if you can imagine. Of all places to find reference to the idea of a fiduciary. here's an excerpt that caught my eye while researching fiduciary info:

In a nutshell A fiduciary duty requires the fiduciary to place the interests of the client ahead of one’s own. Consider fiduciary in the context of the ancient wisdom of the Bible which very sensibly suggests not placing an obstacle before the blind.

I have followed Peter's writing for some time now and find him an indispensable voice for good investor information.

Peter retired after working 30 years as an engineer, and found time devote himself to studying finance and investments. He was serious enough about this to complete the CFA program of study, the highest level of study in my opinion.

His writing is informed, insightful, helpful and contains the rarest element in the world today, and that is UNCONFLICTED HONESTY. There is almost nowhere an investor can go today without being preyed upon by investment experts with a hungry agenda.

Peter is a breath of fresh air in a world otherwise filled with investment salespeople, all disgusied as investment helpers......thanks Peter for continuing to pump out good information to help people. I am proud to have met and talked to you.

As the Securities and Exchange Commission (SEC) continues to examine the possible implementation of a uniform fiduciary standard, investment professionals who operate under suitability guidelines may be wondering how changing to a fiduciary model may impact their business and their client relationships. In an attempt to answer that question—as well as questions about differences in the advice and products registered representatives and investment advisers offer—we surveyed a national sample of nearly 400 investment professionals.

The results of that survey shed new light on the potential benefits to consumers of a uniform fiduciary standard and highlight the perceived impacts of changing one’s standard of care. This article will focus on those perceived impacts and a few of the potential consumer benefits, as well as provide an overview of the current and proposed regulatory landscape.

Current Regulatory StandardsInvestment professionals designated as investment advisers must make recommendations that are in the client’s best interest, as they are required to follow a fiduciary standard. Investment professionals designated as registered representatives must make recommendations that follow a suitability standard; they are not required to make recommendations that are in the client’s best interest (under federal law), but their recommendations must be suitable given the clients’ investment objectives and financial situation.

Any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation as part of a regular business, issues or promulgates analyses or reports concerning securities.

Advice provided by registered representatives is considered incidental to the sale of financial products, whereas advice provided by investment advisers is considered central to their overall services. However, the 2008 RAND technical report Investor and Industry Perspectives on Investment Advisers and Broker-Dealers showed that consumers typically are unable to differentiate between a registered representative and an investment adviser. The RAND report also showed that adding to the confusion is the common practice for broker-dealers to promote and refer to registered representatives as financial advisers, wealth advisers, or financial consultants, implicitly stating that their services include specialized advice.

Fiduciary responsibility has been defined as the minimum obligation that professionals should have toward their clients; it is believed to be part of the contract of engagement between two parties (Laby 2008). The common types of professional relationships for which fiduciary standards may exist include principal-agent, trustee-beneficiary, and director-corporation relationships (Flannigan 2004). The client-investment professional relationship falls under the broader category of principal-agent relationships. Within the framework of a principal-agent relationship, the decisions and actions suggested or taken by the investment professional (the agent) can have long-term consequences for the financial outcomes and decisions of the client. (See “The Fiduciary Obligations of Financial Advisers under the Law of Agency” on page 42 of this issue of the Journal for more on the principal-agent relationship.)

Section 202(a)(11)(C) of the Advisers Act excludes from the definition of an investment adviser any broker or dealer that meets the following requirements: (1) the performance of investment advisory services is solely incidental to the conduct of its business as a broker-dealer, and (2) no “special compensation” is received for advisory services and the broker-dealer does not receive any additional compensation to provide such service to their customers. Thus, income earned by registered representatives often is through commissions from the products they sell.

Currently, there are substantially more registered representatives than investment advisers. Within the confines of the Securities Exchange Act of 1934 and FINRA guidelines, registered representatives are allowed to sell financial products but are not required to have any fiduciary responsibility in advising their clients. They are required to follow the FINRA suitability rule.

According to FINRA Rule 2111 effective July 2012, registered representatives must fulfill three main obligations.

First, a registered representative must have a “reasonable basis to believe, based on reasonable due diligence, that the recommendation is suitable for at least some investors.” Second, the products that a registered representative sells to a client must be suitable to that particular client’s investment profile. The third obligation applies when the representative has control over the client’s portfolio. This obligation imposes an overall suitability determination to a series of transactions, even if each transaction in isolation would be suitable. This obligation takes into account the asset turnover rates, cost to equity ratios, and in-and-out trading from a client’s account.

Proposed Uniform Fiduciary StandardSection 913 of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) required the SEC to examine the potential effects of a uniform fiduciary standard for all investment professionals when they give investment advice to retail investors. Dodd-Frank also authorized the SEC to adopt regulations imposing the same fiduciary duty on brokers—and their representatives—that apply to investment advisers.

In 2011, SEC staff published the Study on Investment Advisers and Broker-Dealers, a lengthy report examining the effectiveness of standards of care. The report concluded by recommending to the SEC the imposition of a uniform fiduciary standard for investment advisers and registered representatives when they offer investment advice about securities to retail investors. The recommendation to the SEC was that the standard be consistent with the one that currently applies to investment advisers.

The survey findings reported in this article are the result of research that was designed, in large part, to determine whether some concerns about the merits of a uniform fiduciary standard are well grounded. The specific research questions addressed include (among others not reported in this article):

Do registered representatives who currently follow a suitability standard perceive that a uniform fiduciary standard would impact them?Do investment advisers and registered representatives recommend the same investment products to their clients?Do investment advisers and registered representatives spend the same amount of time with their clients before they make investment recommendations?The SurveyA 2012 online survey was used to collect primary data for this research study. The survey was designed and administered by faculty in the University of Georgia Department of Financial Planning, Housing and Consumer Economics in cooperation with Matthew Greenwald & Associates, a market research firm. The study sample consisted of 387 investment professionals from 48 states who currently “provide personalized investment advice to individuals or families as part of [their] job.”

Twenty percent of the 387 participants were registered as both an investment adviser (SEC) and as a registered representative (FINRA). These individuals were excluded from the analysis due to the ambiguity associated with following two different standards of care depending on how they work with clients. Thus, responses from 309 participants were examined for this research, including 134 registered representatives and 175 investment advisers. As a result of the constraints faced in reaching out to every financial planner in the country and time and costs associated with it, the sampling methodology used in this study was a convenience random sample.

(note the differences here between the commission sales-person v the advisor....advocate comment)

ResultsWould investment professionals who currently follow the suitability standard advise their clients differently if they were to follow the fiduciary standard instead?

Although all respondents were asked this question, the focus here is on the registered representatives who indicated they follow the suitability standard. Sixty-seven percent of that group did not expect their advice to be different under a fiduciary standard. However, 16 percent of registered representatives expected that their advice might be different if they were to operate under the fiduciary standard and 17 percent didn’t know. This result confirms that in the current situation, in which there are two different standards of care, at least some consumers may in fact receive different recommendations from investment professionals who follow different standards.

The 16 percent of registered representatives who reported they thought their investment advice might change under a uniform fiduciary standard were asked the follow-up question: “Why do you think your investment advice might sometimes be different when following a fiduciary standard?”

As shown in the table, 35 percent of the registered representatives who responded to this question expected their ability to act in the client’s best interest would be greater under a fiduciary standard. Nearly one-half (45 percent) thought they would have the same or a greater range of investment products to recommend to clients, and 49 percent thought there would be a smaller range of products available. The majority (53 percent) thought that under a uniform fiduciary standard they would likely spend more time with their clients.

All survey respondents—both investment advisers and registered representatives—also were asked about the investment vehicles/assets they recommend to clients. They were then asked to estimate the percentage breakdown between actively and passively (index) managed mutual funds they recommend. The results show some clear differences between the two types of investment professionals.

Significantly more registered representatives (83 percent) than investment advisers (43 percent) reported that they recommend a larger percentage of actively managed mutual funds than passively managed funds (t=8.044, p<.001). This further supports the conclusion that ­consumers may receive different guidance from investment professionals following different standards of care.

To determine any differences in the amount of time investment advisers and registered representatives spend with clients before making investment recommendations, survey participants were asked: “When working with a new client, on average, how many meetings either in-person, over the phone, or interactive online (such as using Skype but excluding email exchanges), do you have with your clients before making specific investment recommendations?”

Most investment advisers (86 percent) reported meeting with new clients an average of two or more times before recommending an investment, compared with 35 percent of registered representatives (t=3.052; p<.001). The bar graph illustrates the additional finding that 55 percent of registered representatives said they met with new clients only once, on average, before making an investment recommendation. It is quite alarming that 10 registered representatives and one investment adviser said they did not have a single meeting with a new client before making an investment recommendation.

Although the sample size here is relatively small, the results indicate potentially positive outcomes for clients of these registered representatives if their investment professional were subject to a fiduciary standard. The results also provide evidence (although from a very small subsample from the total sample) to suggest that registered representatives tend to believe that the cost of compliance would likely be higher under a fiduciary standard, but those higher costs would be unlikely to increase the fees clients pay.

ReferencesFlannigan, Robert. 2004. “Fiduciary Duties of Shareholders and Directors.” Journal of Business Law May: 277–302.

Joseph W. Goetz, Ph.D., AFC, CRC®, is an associate professor in the Department of Financial Planning, Housing and Consumer Economics at the University of Georgia.

Swarn Chatterjee, Ph.D., CRC®, is an associate professor in the Department of Financial Planning, Housing and Consumer Economics at the University of Georgia.

Brenda J. Cude, Ph.D., is a professor in the Department of Financial Planning, Housing and Consumer Economics at the University of Georgia, and a consumer representative to the National Association of Insurance Commissioners.

(second advocate comment....my apologies for inserting a comment under one of the graphic images. I could not resist pointing out the different timelines to "get to the investment purchase" (my words) between broker types and advisors. They are two very different roles. Selling investments is NOT giving investment advice, and giving advice is NOT sales.)

My second comment is about the first image, where investment sellers, are asked how they would treat customers differently under a fiduciary standard.......of course they reply "not at all" in the majority. Sadly this is like asking he fox who guards the henhouse if he would treat the chickens any differently if forced to treat them in a different manner. I have yet to meet the investment salesperson who did not (cognitively) tell him or herself that they were acting in the highest professional manner, even when they were cheating customers daily. It seems a dissonance that we all possess)

After beginning her career on Wall Street as a broker, bond trader and later an investment advisor, Kathleen M. McBride ran financial new-media startups with major financial and media companies. Today, she is an Accredited Investment Fiduciary Analyst with The Center for Fiduciary Studies, which is associated with the University of Pittsburgh’s Joseph M. Katz Graduate School of Business. She holds BA degree from New York University and has completed the Investment Strategies and Portfolio Management program at The Wharton School of The University of Pennsylvania.

In 2012 she founded FiduciaryPath, a company whose mission is to ensure that investment fiduciaries are aware of their fiduciary responsibilities and that their investment process is managed to an appropriate fiduciary standard of care. Prior to founding FiduciaryPath, she was a Director at the Institute for Private Investors, Wealth Editor in Chief at AdvisorOne.com, Editor in Chief at Wealth Manager and Senior Editor at Investment Advisor.

She is a founder of The Committee for the Fiduciary Standard and The Institute for the Fiduciary Standard, a nonprofit, nonpartisan think tank dedicated to providing research, education and advocacy on the fiduciary standard’s impact on investors, the capital markets and society. As a participant in dozens of meetings at the most senior levels of the Securities and Exchange Commission, Department of Labor, Treasury, Congress, Consumer Finance Protection Board, FINRA and more, McBride has a unique perspective on investment fiduciary issues.

FN: Kate, tells us a little bit about yourself and your background. It’s rare that an individual takes on such a strong interest in such a narrowly defined subject like fiduciary matters. What led you to where you are today?McBride: Well, originally I was going to be a scientist, or a sports reporter – on air. I figure skated four or five hours a day through high school, and after. I was one of those kids on the ice at 5 am. But I needed to save money for college. So I started at a small Wall Street institutional boutique where I got my Series 7 at 22 and began building a book. I worked my way through NYU. But I was not comfortable with the volatility of equities for my customers. Eventually I left for a larger firm’s muni desk, where I underwrote and traded munis. Bonds were a better fit for me, and at the time they were pretty exciting, as rates were at their peak. I eventually moved on to become an investment adviser to HNW clients at Mani Hani. I was a fiduciary and loved it – it was like finding a home.

Over the years I’ve had the chance to build financial and media businesses, was a financial journalist and now I am an advocate for investors and the importance of the fiduciary standard for investment advice. I’m very proud of the research, education and advocacy that the non-profit Institute for the Fiduciary Standard does. My firm, FiduciaryPath, helps fiduciaries understand their fiduciary responsibilities and best practices, and when their investment processes conform to the global fiduciary standard of excellence, they can be publicly recognized by the Centre for Fiduciary Excellence.

FN: In your mind, what is the ideal Uniform Fiduciary Standard and how would this best protect the interests of investors?McBride: I’m afraid the term “uniform” is being used to eviscerate the centuries-old meaning of fiduciary. Investment advisers providing advice to investors are fiduciaries – they act in the investor’s best interest at all times, (and, under ERISA, solely in the investor’s best interest); they act as a prudent person with the competence and diligence of an expert; they avoid conflicts of interest; they manage unavoidable conflicts in the client’s best interest and disclose them; they control investor’s costs; and, they clearly disclose all investor costs. That’s ideal.

In terms of extending that bona fide fiduciary standard to brokers (as called for in Dodd-Frank), the broker-dealer lobby group, SIFMA, has proposed to SEC a “universal fiduciary standard,” which according to SIFMA’s own blueprint is nothing more than their current lower sales or suitability standard, but masquerading as “fiduciary.” No mention of the fiduciary principles above. SIFMA says extending the fiduciary standard to brokers would limit access to advice, limit access to securities products and cost investors more. None of those assertions is true. SIFMA doesn’t want brokers to have to change their business model. The fact is that the business model SIFMA’s striving to protect is the model where clients serve the broker, not the broker serving the clients – where the broker can or must put themselves and their firms before the client. SIFMA’s main concern is for BDs to continue to sell whatever they want or have to, to an unwitting investor who believes they are getting “advice.” As for cost, what costs less, a fully disclosed fee on assets or an iceberg of hidden fees where the revealed commission is a fraction of the real costs to the investor? SIFMA lobbies against the authentic, bona fide fiduciary standard at every turn, telling regulators and Congress that if brokers had to provide advice as fiduciaries, that investors would lose access to advice. What SIFMA’s really saying is, if our brokers have to provide advice in the client’s best interest, they would refuse to provide advice at all. That sounds like a threat of blackmail to me. But if the advice is adverse to the client, perhaps no advice would be better.

SIFMA’s worried that brokers who sell the highest cost, best for the broker-or-firm junk to investors won’t be able to continue. Perhaps if that’s the model they strive to protect, it should change.

FN: The Institute for the Fiduciary Standard is a relatively new organization. What part did you play in its formation and what do you do for it now? How do you see its role in the promotion of the fiduciary standard? McBride: I am one of seven founders of the Institute, which was formed in 2011 to provide research, education and advocacy for the fiduciary standard in investment advice. The Institute’s founders are: Knut Rostad, president, Marion Asness, Philip Chao, Maria Elena Lagomasino, Jim Patrick and Michael Zeuner. Personally, I’m very proud of the work the Institute has done to keep the authentic, bona fide fiduciary standard in front of regulators and legislators, in the media and with the many special events and policy discussions the Institute has hosted.

FN: Together with fi360 and ThinkAdvisor, you’ve been involved with annual surveys of the industry on fiduciary matters. What are some of the trends you see coming out of those surveys? Do these trends give you a sense on how the industry might begin to promote the fiduciary standard, whether or not the SEC formally adopts one?McBride: For the past three years, the fi360-ThinkAdvisor Fiduciary Survey has studied the attitudes of financial intermediaries about the fiduciary standard. We invite participation of all kinds of financial and investment advisors – registered investment advisers, investment adviser reps, registered reps, insurance producers and consultants, attorneys, family office leaders. We look at the data cross tabulated by type of registration and by compensation model. What’s most surprising: the majority, including brokers, say extending the fiduciary standard to brokers will not cost investors more – (many commented that advice under the fiduciary standard would cost investors less!) – nor would it deny them access to advice or choice of products (except the most egregious). The other findings that stand out are that across the board, the majority said the even more stringent ERISA fiduciary standard should apply to advice to 401k AND IRA participants, as well as money rolling over from those types of accounts. This is a real departure from what SFIMA says B-D leadership wants – there’s a real difference of attitude in the trenches than in the executive suite of brokerage firms and insurance companies.

FN: What’s your biggest fear regarding the involvement of regulators in the drafting of a new fiduciary standard and how might that impact investors.McBride: That it will be watered down to a faux fiduciary sales standard, and then further confuse and abuse investors. You mentioned in an article last year that each month regulators delay requiring everyone who provides advice to do so under the bona fide fiduciary standard costs investors $1 billion (see “Study: SEC Fiduciary Delay Costing Retirement Investors $1 Billion per Month,” FiduciaryNews, February 12, 2014). That means since the fiduciary standard was called for in the Blueprint for financial reform in May 2009 the cost to investors is $56 billion extra. That’s staggering! For many retirement plan participants, the DOL’s embrace of many more advisors to plans and participants and on rollovers cannot happen too soon. It can mean $150,000 or more in a person’s retirement account over an investor’s career. These numbers are very meaningful and could be the difference in whether a person can retire with dignity – or not at all.

FN: You’ve had a chance to see up close what regulators are thinking. Do you believe they acknowledge the academic research that shows the cost of conflicted advice to investors? If not, why do you think they might be ignoring it?McBride: Many of the regulators I’ve met are very conscious of that research, welcome it. Many would like to hear from more fiduciaries. I do not think they are ignoring the research. But I think the pressure SIFMA and the insurance lobbies are putting on are enormous. The money the industry is throwing at this is huge. But I have been puzzled about why brokers and the insurance industry so willingly talk about loud about throwing their customers under the bus, and yet they’re surprised about the patter of investor feet away from them.

FN: Without naming names, can you share with our readers any horror stories you’ve seen in the real world that resulted from investors or plan sponsors not using a fiduciary for investment advice?McBride: I once saw a 401k where the company fiduciaries were so blatantly violating their fiduciary duty that they threatened to fire an employee who brought it to their attention. And there are many more just like that – 401k plans managed by the CFO’s brother-in-law or golf buddy.

FN: What do you think can or should be done to allow for broader awareness on the part of everyday investors regarding fiduciary issues?McBride: Media coverage is a key to investors starting to understand the differences among those who advise or sell to them. Titles are a simple and effective way to differentiate sales from advice. The SEC has to stop allowing the B-D exemption to continue “incidental advice.” That was a big mistake in 2005 that they could easily correct.

FN: You’ve done so much in the fiduciary field that we’re bound to have left out something. Is there anything more you think our readers should know?McBride: There’s a relatively simple solution to this. Eliminate the broker-dealer exemptions and the ERISA exceptions. For the many brokers who want to put clients first under the real fiduciary standard, have them obtain the training and credentials to live up to the responsibilities of the bona fide fiduciary standard. Permit only those to have titles that convey a fiduciary duty–advisor, consultant, counselor, wealth anything, etc. Those who want the status quo get the time honored sales titles. Ensure in a one page disclosure that the investor knows and affirmatively circles which relationship they want. And no dual registrant hat tricks!

FN: Thank you so very much Kate, for taking the time to share your thoughts. Your work is inspired as well as inspiring. We know FiduciaryNews.com readers really appreciate hearing from someone like you who has veteran front-line familiarity with all things fiduciary.

“When I interviewed for the position as Chair and CEO of the Alberta Securities Commission now close to nine years ago, I was asked about my views on self-regulation. Being a lawyer and having enjoyed the privilege of the self-regulation of the legal profession for some 32 years, I did not have much difficulty in quickly expressing my support.”

(In the legal profession the existence of a fiduciary standard aligns both the incentive and the standard. Whether he realises it or not, Bill Rice has unwittingly argued for the introduction of best interests standards as a solution to the regulatory burden.)

First my own simple analogy, with a visual, showing how I believe the investment industry gets to make additional billions, while cheating or shortchanging investment consumers. (note, this applies to Canadian as well as US investors)

Second, a publication by a major Canadian law firm speaking to the same issue in terms more understandable to those who prefer legalese. (theirs is better, mine shorter:)

#1. The photo on the top is the industry promise, and the photo on the bottom is the industry delivery, about 80% of the time. Simply put, the industry ability to mislead customers into a false sense of trust in commission salespersons, while implying and pretending that they are trusted professionals, is the foundation for cheating 330 million North Americans out of hundreds of billions of dollars.

News from globeandmail.comAdvisers, and rules they thrive by, need to come out of the shadows

Thursday, December 19, 2013BRIAN MILNERCanadian securities regulators have put off making a decision on whether to impose tougher rules on mutual fund commissions and other aspects of the relationship between financial advisers and their clients. Instead, they're going to do some more nattering and weighing of the information they've been gathering.

That has brought shouts of joy from some of Canada's financial advisers. Advocis, the advisers' lobby group, and its investment allies have been fighting a rearguard action against any moves that would force the industry to abandon its opaque commission practices, put an end to egregious conflicts of interest and start treating clients as if their interests actually come first.

Last month, the industry released a report it commissioned that just happened to reach the conclusion it was seeking: "There is no gap in Canada that need be or could be filled by imposing further statutory obligations on investment advisers and dealers."

The industry would settle for endless jawing that puts off as long as possible any interference with a business model that works extremely well for everybody but the overpaying customer. That means keeping things like the actual costs to investors hidden and avoiding more stringent safeguards that would it make it easier for aggrieved clients to sue advisers who steer them into inappropriate securities for the sake of fatter commissions.

"This cautious and reasoned approach is the right course because there's so much at stake," Advocis president Greg Pollock intoned in a statement. "A wrong decision could have devastating consequences, so we're relieved that the regulators are taking the time to consider all the facts."

Advocis and its advocates are working particularly hard to preserve the commission fees embedded within mutual funds. The industry-wide practice of paying trailing commissions is a terrific lure for financial planners - even as it leaves them open to obvious conflicts of interest. Most sensible people, including the Ontario Securities Commission's investor advisory panel, want the practice prohibited.

Advocis's ludicrous response is that this "would drive up the cost of financial advice, making it unaffordable for hundreds of thousands of middle-class Canadians." It doesn't mention that Canadians already pay far too much in both open and hidden costs compared with investors in other countries.

In response, the lobby group warns that costs are already shooting up in Britain, where millions of people could wind up as "financial advice orphans" as the result of new regulations.

Yikes. Is it really better to have a conflicted adviser peddling expensive funds to unsuspecting investors for personal gain? Frankly, I'd rather be an orphan.

Financial advisers regard themselves as well-trained professionals providing impartial advice based on their extensive homework and in accord with their clients' goals, incomes and levels of risk tolerance. Many do fit that description; the others could start by taking their murky compensation deals out of the shadows and committing themselves to putting their clients' interests first.

It's called fiduciary duty, and the industry should stop acting as if this would mean sure financial ruin. Other professionals, such as lawyers and accountants, have become quite prosperous with transparent fee-for-service arrangements.

Instead, Canadian advisers seem to prefer their role as well-compensated salespeople, raking in fat commissions for peddling securities that may or may not be in their clients' best interests, but most certainly are in theirs.

"...Advisors who must meet a “suitability standard” are required only to offer advice that’ssuitable for their clients, which means they can suggest products that earn them big commissions but that aren’t necessarily the best choice for the client. Financial advisors who must meet a “fiduciary standard” are legally obligated to put their clients’ interests first.Think of it this way. Some advisors say, “If there are two products and they’re both decent, I’ll always select the one that pays me more.” But others say, “If there are two products to choose from and they’re both similar and appropriate, I’ll always select the one that costs the client less.”....."

Interview with Steven D. Lockshin, author of Get Wise to Your AdvisorAll of us could use some advice on how to manage our finances. But Steven D. Lockshin says we ought to heed a billboard-sized warning: Be careful out there.

“[T]he financial advice industry,” he says in his important new book Get Wise to Your Advisor: How to Reach Your Investment Goals Without Getting Ripped Off, “has more built-in conflicts of interest than almost any other industry.”

Lockshin knows whereof he speaks. He’s consistently been one of the top-rated financial advisors in the country by Barron’s and for 20 years he ran his own fee-only, conflict-avoiding advisory firm. Now he’s helping the rest of us figure out whom we can trust for honest guidance about money matters.

Because the book was so revealing, I asked Lockshin to answer some questions about his book for readers. He’s also provided an outstanding 8-page PDF on the questions you should ask anyone aiming to give you financial advice.

At the heart of the book is the distinction between advisors who must meet a “suitability standard” and those who must meet a “fiduciary standard.” It sounds a bit wonky, but it’s a big deal. Explain.

Advisors who must meet a “suitability standard” are required only to offer advice that’s suitable for their clients, which means they can suggest products that earn them big commissions but that aren’t necessarily the best choice for the client. Financial advisors who must meet a “fiduciary standard” are legally obligated to put their clients’ interests first.

Think of it this way. Some advisors say, “If there are two products and they’re both decent, I’ll always select the one that pays me more.” But others say, “If there are two products to choose from and they’re both similar and appropriate, I’ll always select the one that costs the client less.”

Ok. So how do I determine which is which?

In its simplest form, a fiduciary – a true steward of your financial well being – will always place your interests first. Full stop. Any conflict of interest should be a yellow (if not a red) flag that your advisor may be tempted to put their interests before yours.

What else should we be looking for in an advisor?

Make sure your advisor has the skills and qualifications to meet your needs. Check his or her violations history through FINRA’s or the SEC’s website and ask lots of questions to understand the advisor’s level of education and experience in the financial services industry. You’ll be surprised to know that there are almost zero education requirements to become a financial advisor.

Do all of us really need an advisor? Can’t we do a lot of this work online on our own?

It’s possible to handle your investments and savings on your own, provided you possess one important skill – discipline. There are also online solutions like Betterment.com or Wealthfront.com and others that automate investing and savings for you at a fraction of the cost of retail advisors – and do it quite well! However, here’s the key: The math is simple, but the emotion and discipline are not. Much like dieting, most of us know what to eat and how to exercise; yet we often need a trainer or dietician to assist with our discipline. A good financial advisor can help with that discipline.

What’s one thing Pink Newsletter readers could do today to improve their chances of successfully navigating their financial futures?

Probably the most important thing is making an honest assessment of one’s current situation. Ask a few really simple, but extremely important, questions. For example:

1) Am I disciplined about my financial planning process or do I rely on someone else to do my thinking for me?

2) Do I truly understand what I am paying in fees?

3) If I do rely on someone else, am I confident that person is dedicated to meeting my needs without any economic conflicts of interest that could get in the way?

4) Have I religiously searched for the best advisor to meet my needs by asking tough questions rather than making an emotional decision?

For more, check out the book Get Wise to Your Advisor: How to Reach Your Investment Goals Without Getting Ripped Off and this free PDF on the questions you should ask any prospective advisor.

It took Tony Warren more than two decades to change his mind about investment advisers.

“I had a very good broker – a tremendous guy, very intelligent,” Mr. Warren says of his adviser at Canaccord Genuity Wealth Management in Edmonton. The two men had a good rapport, but “I still always felt like I was being herded into things.” Instead of looking for long-term investments, “they would get hot on a stock and get me into it. ... If I wouldn’t trade, they would get upset.”

The vast majority of investment advisers are paid through commissions. Each time they buy or sell shares, their clients must pay them a fee for executing the trades. For them, the most lucrative customers are people like Mr. Warren, who has the sort of healthy six-figure portfolio that can support frequent trades.

For years, Mr. Warren went along with his broker’s advice. His annual fees and commissions amounted to tens of thousands of dollars. “I didn’t think there was another game in town,” he says. Over time, he started to question his adviser’s motives, and began ignoring his pitches to invest in junior mining and energy stocks.

That did not sit well with his adviser, and the relationship frayed. About three years ago, he says, “they ‘fired’ me.”

At first Mr. Warren was confused. How could he be dismissed as a client? Now he says it was the best thing that could have happened to him. His anger pushed him to do some serious research, which led him to the conclusion that he never should have settled for an adviser who saw him as a fee machine. (Canaccord Genuity declined to comment on its relationship with Mr. Warren.)

Canadians who have found themselves in Mr. Warren’s situation can take some solace that regulators are watching. For the first time in two decades, the country’s provincial securities watchdogs have proposed significant reforms to the multibillion wealth management industry and the fees and incentives that advisers receive.

Regulators have already laid the groundwork for more robust disclosure of the fees that investors pay, and mutual fund companies may have to curtail the amounts they pay to advisers in return for selling their products. These are, potentially, radical shifts in a business that has been slow to change. Dave Agnew, head of Canadian wealth management at Royal Bank of Canada, calls it the “largest challenge that the wealth management industry has faced in many, many years.”

Yet some advocates for reform are skeptical about their chances of success. The major chartered banks are a powerful lobbying force, and they have become more dependent than ever on fees from wealth management – it’s a safe harbour as other streams of revenue decline. And despite the regulators’ copious legwork, which includes holding hearings and a conducting a thorough study of mutual fund fees, critics are unimpressed. They say they have seen this all before.

In 1994, the Ontario Securities Commission hired retired securities lawyer Glorianne Stromberg to study the industry’s problems and to propose fixes. Her report was scathing, but little changed. Today her proposals are even bolder, going so far as outlawing the title “investment adviser.” “It’s a travesty,” she says. Clients hear the word “advice” and think the brokers will always look out for their best interest. A more accurate job title, in Ms. Stromberg’s view, would simply be “salesperson.”

Canadians have more than $3-trillion in financial wealth, and pay billions in fees and commissions annually. Will the securities watchdogs have sufficient grit to crack down on conflicts of interest in how that money is managed? Or will backroom pressure by financial institutions put the kibosh on their efforts?

Paid according to ‘the grid’

The list of critics who believe the current system is a blight on the industry includes some individual investment advisers. Ottawa’s Marc Lamontagne came to resent the commission model. “I thought I was a financial planner,” he says, reflecting on his early days in the industry during the 1990s, working for now-defunct Regal Capital Planners. “In actual fact, what I should have been was a salesman. That was the only way to make money.”

It wasn’t long before Mr. Lamontagne, who is now an independent financial planner, shunned commissions for a model that charged his clients a fixed percentage of their portfolio each year. Today his clients have a firm grasp on what they will have to pay, and everything is in the open.

That differs from the prevailing model, which gives investment advisers a strong incentive to maximize their commissions. Across Canada, the vast majority of brokers are paid according to “the grid,” a sliding scale that dictates what cut of client fees flow to them, and what percentage their firm keeps. At CIBC Woody Gundy, the retail brokerage arm of Canadian Imperial Bank of Commerce and one of the largest such firms, an adviser whose revenues amount to $375,000 a year brings home, on average, 38 per cent of that, or $142,500, according to a copy of the bank’s grid obtained by The Globe and Mail.

While the exact percentage fluctuates from firm to firm, they share a key principle: The more an adviser brings in, the bigger his or her slice of the pie becomes. Brokers who generate revenues of at least $1-million a year are usually entitled to at least 50 per cent of the fees they bring in.

Commissions, not investor returns, also dictate industry status. Retail brokerages typically reward their top advisers by admitting them to special clubs – BMO Nesbitt Burns’ is known as the President’s Council – even though the designations often have no connection to portfolio performance.

To hit these targets, advisers rely on more than trades. Mutual fund companies offer advisers a split of the annual fees that investors pay them to manage their money. These payments, known as trailer fees, typically add up to 1 per cent annually.

Fund companies argue that these fees compensate brokers for their ongoing research and due diligence. In private, industry executives admit that trailer fees exist only to encourage brokers to sell their products. “If it doesn’t pay a trailing commission, it doesn’t make it onto [a broker’s] product shelf,” says John DeGoey, who now manages Mr. Warren’s money and is one of the most vocal investment advisers in favour of reforms. “That limitation is one that most clients are oblivious to.”

Fund companies can remunerate advisers so generously because Canadians cough up some of the highest mutual fund fees in the world. There’s plenty of money at stake: Mutual funds remain the country’s most widely held type of investment, with assets of $762-billion as of December, 2011.

Advisers can also earn extra commissions for helping their firms sell share offerings. If, for example, Enbridge Inc. sells stock in order to raise money for pipeline construction, the investment banks will entice their advisers to purchase the new shares for their clients by paying them a special 50/50 commission. If the bank earns 4 per cent in fees – or $4-million on a $100-million share sale – the adviser will earn a 2 per cent cut on each share they convince their clients to purchase. An adviser who sells $1-million worth of new shares earns a cheque worth $20,000 – often in a matter of minutes.

Advisers are so richly rewarded partly because investment banks are in an arms race to build the most powerful sales force. National Bank of Canada, for one, has invested heavily in expanding its network of investment advisers by buying investment dealer Wellington West and the advisory arm of HSBC Bank Canada in 2011. And this summer, National more than doubled the size of its network of independent retail advisers, who pay National both for the right to use its back office systems and to participate in the share offerings that its investment bank underwrites. “That’s why we’re in so many deals,” chief executive officer Louis Vachon said recently.

Then there are the less conventional avenues for earning fees. Unlike mutual funds, which earn steady annual management fees, hedge funds earn both a small annual fee from their investors, plus 20 per cent of any returns above a certain threshold.

Earlier this year, senior managers at a Canadian hedge fund met with top retail brokers across the country to pitch their products. Officials with the hedge fund, which asked to remain anonymous for fear of retribution from banks, said the reception seemed generally positive. But when they followed up with advisers to see if there was any sales interest, the message suddenly changed. A top broker at a Big Six bank shrugged the firm off, explaining that “we will only do funds [in which] we participate in the performance fees,” according to an e-mail obtained by The Globe and Mail. The adviser wanted a cut for simply placing clients in these funds, even though the investors and the fund managers absorbed all the risk.

A fee-based model

Facing the prospect of a changed rulebook, financial institutions say they have an easy fix: shepherding clients toward fee-based accounts, as Mr. Lamontagne does. Advisers are paid a straightforward percentage of the money they manage – typically about 1 to 2 per cent of the assets under their watch – and they forgo mutual fund trailer fees and commissions on stock trades.

Because the fee structure is simple and clearly stipulated, advisers are free to work in the best interests of their clients. They are also incentivized to earn superior returns for their clients: The more the portfolio grows, the more they get paid. This model is quickly becoming the new norm outside of Canada. Recently the U.K. and Australia banned commission-based accounts, and there is speculation that the European Union will soon follow suit.

Yet fee-based accounts have existed for years in Canada, and only a small fraction of investors have heard of them. Investor Economics, an independent industry research outfit based in Toronto, concluded in June that fee-based accounts “have yet to gain significant traction in terms of assets or adviser penetration,” and found that they only make up 28 per cent of client assets outside of mutual funds.

Some investors, unlike Mr. Warren, prefer the commission model exactly because it incentivizes their brokers to buy and sell often and, ideally, earn quick profits.

The fee-based model can also be gamed. Advisers who asked to remain anonymous because their organizations do not allow them to speak to the media told The Globe and Mail that a number of their peers are secretly “double-dipping”: running fee-based accounts while still collecting trailer fees and commissions on sales of new securities.

The issue blew up at Royal Bank of Canada this spring, according to a source within the company, prompting the bank to crack down in a number of closed-door meetings. No official notices or decrees were sent out, but a number of advisers were reprimanded. Mr. Agnew, the bank’s Canadian wealth management head, acknowledged the actions in an interview, adding that RBC’s compliance department monitors client accounts closely to catch such behaviour.

Wealth management bonanza

Regulators have made some headway. This past summer, provincial securities regulators started phasing in new rules that require advisers to disclose to clients the full amount they paid in fees and commissions each year. Financial institutions have backed such reforms. “We support full disclosure,” says Rajiv Silgardo, head of BMO Asset Management. Investors “need to know all the costs that they will bear.”

But Mr. DeGoey, one of the advisers who backs major reforms to how the industry’s 22,000 brokers are paid, worries that the changes will stop there. He argues that the industry only supports “these wussy disclosures that don’t really alter behaviours.”

Part of the problem is that the existing system has served financial institutions well. Wealth management has become a major profit centre. Sun Life Financial Inc. recently re-launched its asset management business, and each of the Big Six banks made wealth management acquisitions or invested heavily in their existing businesses in the past three years. Wealth management now accounts for 20 per cent of Bank of Nova Scotia’s profits, up from 3 per cent a decade ago. As their traditional operations struggle, wealth management makes up between 35 and 45 per cent of some life insurers’ bottom lines. The pressure to keep their wealth management businesses growing will not abate any time soon.

The official line is that the current system has served customers well too. “The current advice compensation model in Canada aligns the dealer’s and adviser’s compensation with the client’s goals,” Mackenzie Investments wrote in a public letter to the Ontario Securities Commission this summer. A unit of DundeeWealth, now owned by Bank of Nova Scotia, also wrote to warn against the more radical reforms of the U.K. and Australia: “The commission-based model is suitable for some investors while the fee-based model is suitable for others.” Canadian regulators “should not dictate that only one option is available.”

Reaching consensus on a new rulebook will not be easy. Not only do the provincial securities commissions amount to a patchwork quilt spread across the country, they must collaborate with industry-specific, self-regulating bodies such as the Investment Industry Regulatory Organization of Canada and the Mutual Fund Dealers Association of Canada, each of which have their own priorities.

The groups must also withstand heavy backroom pressure. Ed Waitzer, the OSC chair who hired Ms. Stromberg to conduct her research in the 1990s, recalls facing huge resistance when he tried to act on it. “There was a lot of lobbying going on behind the scenes,” Mr. Waitzer said. Financial institutions dragged out discussion of the initiatives for years until the proposals eventually died.

Mr. Waitzer is sympathetic to those who believe nothing will change this time around. “As regulation has become bureaucratized, regulators have gotten in the same habits of politicians: making it look like we’re solving problems, rather than actually solving problems,” he said.

He thinks the regulators should opt for simple, but powerful, rules. In the U.K., he said, the Financial Services Authority recently implemented reforms that hold senior managers’ feet to the fire. If something happens under their watch, the bosses are responsible. Mr. Waitzer also argues in favour of creating standard, low-cost funds that would be the default choice for the risk parameters of the average investor.

For now, the OSC, the country’s most powerful regulator, won’t say much because it is in the midst of its mutual fund review. In June, the commission held a public roundtable to hear from industry voices, and it is still doing research. The last thing the OSC wants is to seem biased in either way in the midst of the process.

However narrow, there appears to be a window for change. The banks’ position is that they are willing to go along with some sort of overhaul. Exactly what that will look like is the question.

“I do not apologize for charging for advice,” says Glen Gowland, head of Scotiabank’s private client group. “But a client should know what they’re paying for, they should be able to understand how much they’re paying for that, and then be able to measure, ‘Did I get good value for what I paid?’ ”

Michael Finke, Ph.D., CFP®, is an associate professor and Ph.D. coordinator in the Department of Personal Financial Planning at Texas Tech University. His research interests include behavioral personal finance, retirement income planning, investor risk tolerance, and mutual fund performance. He is the editor of the Journal of Personal Finance. (michael.finke@ttu.edu)

Thomas P. Langdon, J.D., LL.M., CFP®, CFA, is a professor of business law and director of the Sovereign Bank Center for Business Support at the Gabelli School of Business, Roger Williams University.

Executive SummaryConsumers who rely on the financial advice of experts are at an information disadvantage that may be exploited by advisers who are not required to make recommendations that are in the best interest of the customer.

An early legislative version of the 2010 Dodd-Frank Act would have eliminated the broker-dealer exception from the definition of investment adviser under the Advisers Act. If enacted, this change would have subjected brokers to a common-law fiduciary standard (like investment advisers), but was postponed to examine the consequences of this policy change.

It has been suggested that the imposition of a fiduciary standard on registered representatives would result in significant changes in how broker-dealers conduct business by limiting a representative’s ability to recommend commission investments, provide advice to middle-market clients, and offer a broad range of financial products.We take advantage of differences in state broker-dealer common-law standards of care to test whether a relatively stricter fiduciary standard of care affects the ability to provide services to consumers. We find that the number of registered representatives doing business within a state as a percentage of total households does not vary significantly for states with stricter fiduciary standards.

A sample of advisers in states that have either a strict fiduciary standard or no fiduciary standard are asked whether they are constrained in their ability to recommend products or serve lower-wealth clients. We find no statistical differences between the two groups in the percentage of lower-income and high-wealth clients, the ability to provide a broad range of products including those that provide commission compensation, the ability to provide tailored advice, and the cost of compliance.Financial advisers provide expert assistance selecting financial instruments for retail customers. Registered representatives of broker-dealers facilitate the sale of securities and often provide financial advice to clients who are less knowledgeable about the product. This imbalance of information has led to the imposition of a legal fiduciary standard when an informed agent is hired to make decisions on behalf of a less-informed client (Frankel 1983). In the absence of an informational imbalance between registered representatives (or brokers) and their customers, the primary service provided through broker-dealers is to sell retail financial products demanded by the customer. However, many broker-dealers have suggested through advertising and by referring to registered representatives with terms such as “financial planner” or “financial consultant” that their services include planning or consulting services that involve the provision of expert advice (Hung, Clancy, Dominitz, Talley, Berrebi, and Suvankulov 2008). Most consumers assume that advising services are provided by registered representatives of broker-dealers (Hung et al. 2008).

While consumers are generally unable to distinguish between investment advisers whose primary purpose is to provide investment advice and registered representatives whose advice is considered incidental to the sale of financial products, they are regulated by two different entities that apply different market conduct standards. Investment advisers are regulated by the Securities and Exchange Commission (SEC or Commission) under the Investment Advisers Act of 1940 (Advisers Act) as fiduciaries, and a fiduciary standard of care is applied to the advice given to their clients. Registered representatives of broker-dealers are regulated under the Securities Exchange Act of 1934 through the Financial Industry Regulatory Authority (FINRA), a self-regulatory organization. Registered representatives must meet a standard of suitability when providing information about financial products, and are not assumed to have a fiduciary responsibility toward customers.

The difference in regulation between investment advisers and brokers affects the market for financial advice. The sale of professional advisory services to a less-informed client involves significant potential agency costs that exist when the interests of the client and broker/adviser are not perfectly aligned (Jensen and Meckling 1976). These costs occur when the broker recommends products that benefit the broker to the disadvantage of the customer. Examples of agency costs include recommending products that have higher commissions or not taking the time to consider alternative financial strategies for a customer. It is possible that the application of a suitability standard to investment advice will lead to greater agency costs. A suitability constraint allows brokers to recommend products that are not necessarily in the best interest of the client but may be considered potentially suitable given the customer’s characteristics and needs. This latitude in product recommendation among registered representatives provides a greater opportunity to extract customer rents than would be possible under the constraints of a fiduciary standard (Cummings and Finke 2010). If the suitability standard provides greater opportunities to extract rents from clients, we would expect the broker-dealer industry to defend its ability to maintain this advantage by continuing the existing regulatory regime.

If, however, a fiduciary standard were applied to registered representatives whose sole purpose is to facilitate the sale of financial instruments within a competitive marketplace, the imposition of a fiduciary standard to these sales activities might have a negative impact on the ability of broker-dealers to provide a variety of financial products to consumers. Many consumers may demand products whose appropriate use is difficult for a registered representative to defend as being in the customer’s best interest. For example, there may be mutual funds that pay a commission to the broker that are less efficient than comparable mutual funds that pay no commission. The brokerage industry has argued that since moderate-income clients are less attractive to investment advisers, who are often compensated based on a percentage of assets under management, these clients often seek financial advice from registered representatives compensated through product commissions (Headley 2011). These less-wealthy clients may be less able to receive much-needed financial advice incidental to the sale of commission products if brokers incur increased liability under a fiduciary standard. The application of a standard of care that assumes a fiduciary relationship between registered representative and customer may constrain the ability to make product recommendations and limit the range of available financial products.

While the industry has suggested that fiduciary regulation will have an adverse impact on the industry, there are no existing empirical studies that examine the impact of a change in regulatory policy on the marketplace for financial advice. This study takes advantage of heterogeneity in broker-dealer regulation among states to test whether a relatively more strict application of a common-law fiduciary standard of care affects the number of registered representatives doing business within the state. We also conduct a survey to assess differences in perceived ability to provide financial products among states subject to stricter fiduciary standards. We find that the saturation of registered representatives within states does not vary significantly among states with different fiduciary regulation. When registered representatives in states that have a stricter fiduciary standard are asked whether they are constrained in their ability to recommend products, or whether they are unable to serve lower-wealth clients, we find no statistical difference between representatives from states that do and do not apply a common-law fiduciary standard.

BackgroundOn July 15, 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Section 913 of the Dodd-Frank Act required the SEC to conduct a study to evaluate, among other things, (1) the effectiveness of existing legal or regulatory standards of care (imposed by the Commission, a national securities association, and other federal or state authorities) for providing personalized investment advice and recommendations about securities to retail customers; and (2) whether there are legal or regulatory gaps, shortcomings, or overlaps in legal or regulatory standards in the protection of retail customers relating to the standards of care for providing personalized investment advice about securities to retail customers that should be addressed by rule or statute. In one of the early legislative drafts, Dodd-Frank would have eliminated the broker-dealer exception from the definition of investment adviser under the Advisers Act, but the legislation as adopted included a compromise to conduct further study of the issue.

In January 2011, the SEC released its Study on Investment Advisers and Broker-Dealers (Staff of the U.S. Securities and Exchange Commission 2011). In its report, the SEC staff noted that “the regulatory regime that governs the provision of investment advice to retail investors is essential to assuring the integrity of that advice and to matching legal obligations with the expectations and needs of investors,” and found that investors are often confused by differing standards of care that apply to investment advisers and broker-dealers. The SEC study recommended the adoption of a uniform fiduciary standard for investment advisers and broker-dealers that provides:

The standard of conduct for all brokers, dealers, and investment advisers, when providing personalized investment advice about securities to retail customers (and such other customers as the Commission may by rule provide), shall be to act in the best interest of the consumer without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice.

The SEC study recommends that the Commission, in implementing a uniform fiduciary standard, should engage in rulemaking and provide interpretive guidance addressing the two major components of a uniform fiduciary standard: the duties of loyalty and care. When addressing the duty of loyalty, the report suggests that a uniform fiduciary standard will obligate both investment advisers and broker-dealers to eliminate or disclose conflicts of interest. The report notes, “[t]he Commission should consider whether rulemaking would be appropriate to prohibit certain conflicts, to require firms to mitigate conflicts through specific action, or to impose specific disclosure and consent requirements.” When it comes to duty of care, the study suggests that minimum baseline professional standards should be adopted that could include, for example, specifying what basis a broker-dealer or investment adviser should have in making a recommendation to an investor.

Any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation as part of a regular business, issues or promulgates analyses or reports concerning securities.

Section 202(a)(11)(C) of the Advisers Act excludes from the definition of an investment adviser any broker or dealer that meets the following requirements: (1) the performance of investment advisory services is “solely incidental” to the conduct of its business as a broker-dealer, and (2) no “special compensation” is received for advisory services.

Investment advisers owe their clients a fiduciary duty of care (SEC v. Capital Gains Research Bureau Inc. 1963; Transamerica Mortgage Advisors Inc. 1979). The fiduciary standard that applies to investment advisers encompasses the adviser’s entire relationship with its clients and prospective clients (SEC v. Capital Gains Research Bureau Inc. 1963) and imposes a duty of loyalty and a duty of care.The duty of loyalty requires a fiduciary to act in the best interests of the client, even if doing so may not be in the financial interests of the fiduciary. Under the duty of loyalty, a fiduciary is required to disclose potential conflicts of interest so that the client is aware of those matters where the adviser, either consciously or unconsciously, might render advice that was not in the best interest of the client (SEC v. Capital Gains Research Bureau Inc. 1963).

The duty of care requires a fiduciary to “make a reasonable investigation to determine that it is not basing its recommendations on materially inaccurate or incomplete information” (U.S. Securities and Exchange Commission 2003). Investment advisers, as fiduciaries, must make suitable and reasonable investment advice to their clients based on the client’s financial situation and investment objectives.

Broker-Dealers. Traditionally, a broker-dealer has acted as an intermediary between a buyer and seller of securities. Unlike investment advisers, who are subject to a fiduciary standard, broker-dealers have traditionally been subject to a less stringent “suitability standard.” The suitability standard requires broker-dealers to provide suitable investments to customers, but does not require the broker-dealer to act in their best interest.

Broker-dealers do, however, have an obligation to deal fairly with customers. Courts have found that broker-dealers make an implicit representation to customers that they will be treated fairly in a manner that is consistent with the standards of the profession (Charles Hughes & Co. v. SEC 1943). Through various rulemaking initiatives, FINRA (and its predecessor organization, the National Association of Securities Dealers, or NASD) has helped define the duties implied by this fair dealing standard. Among these duties are requirements for broker-dealers to have a reasonable basis for recommendations that are made after considering the customer’s financial situation (a “suitability standard”) (NASD Rule 2310); engage in fair and balanced communications with the public (NASD Rule 2210(d)); provide timely and adequate confirmation of transactions; provide account statements (NASD Rule 2340); disclose conflicts of interest (NASD Rule 2720; NASD Rule 3040); receive fair compensation in agency and principal transactions (NASD Rule 2440; FINRA Rule 5110(c)); and give customers an opportunity to resolve disputes through arbitration.

Broker-dealers typically hire agents to provide their services directly to the public. Stockbrokers, for example, are considered agents of a broker-dealer. This agency relationship further complicates matters (and leads to confusion by the public about the varying standards that apply to investment advisers and broker-dealers) because an agent owes his or her primary duty to the principal (which, in this case, would be the broker-dealer). The duty of loyalty owed to the principal (broker-dealer) transcends any duty that the agent may have to a customer while acting in the role of an intermediary.

While broker-dealers are not subject to the fiduciary standard under federal law, state common law may impose a fiduciary standard on broker-dealers providing services within that state in addition to rules and regulations imposed by the federal government for transactions and services. Courts in four states have chosen to impose an unambiguous fiduciary standard on broker-dealers.

Study ObjectiveAs a response to the regulatory problems and perceived fraud in financial markets that contributed to the recent financial crisis, Congress passed, and the president signed into law, the Dodd-Frank Act. Prior to the financial crisis, some private self-regulatory organizations, such as Certified Financial Planner Board of Standards Inc. (CFP Board) sought to distinguish designees from other providers of financial services by holding certificants to a fiduciary standard of care when dealing with clients. These events, along with a perception by lawmakers that higher standards should be applied to providers of financial products and advice, led Congress to call for the completion of a study by the SEC to determine whether it would make sense to impose a unified fiduciary duty of care on both investment advisers and broker-dealers when providing personalized investment advice.

While there has been some recent convergence of the regulatory duties performed by investment advisers and broker-dealers over time, particularly in the area of disclosure, there remain some differences in the scope of services provided by these professionals. Investment advisers have traditionally served higher-income/higher-net-worth clients and are often compensated on an assets under management basis. Depending upon the scope of the engagement, and whether they hold discretion, investment advisers may also hold a duty of care to clients to carefully monitor investment performance. Beginning in the late 1980s and early 1990s, the landscape for the delivery of investment advice began to shift when broker-dealers began to increasingly offer financial advice, relying on the “solely incidental” exemption in the Advisers Act or becoming dually registered as investment advisers to provide fee-based advisory services. The investment advice provided on the brokerage side, however, tends to be episodic and focused on specific products and transactions that are suitable for a given client. Broker-dealer agents are usually compensated on a commission basis, and traditionally do not owe customers an ongoing duty to monitor their client’s financial position. Broker-dealers have claimed to provide lower-cost advisory services, offset by transaction fees, for customers who do not wish to pay, or cannot afford to pay, the higher direct fees charged by investment advisers.

Due, in part, to the imposition of the suitability (as opposed to fiduciary) standard on broker-dealers, the current debate over the costs of providing advisory services to retail customers has focused on the potential economic effects of broker-dealers being held to the higher fiduciary standard of care. The brokerage industry argues that the imposition of a fiduciary standard will result in an increased risk of a fiduciary breach that would have the effect of increasing the compliance and liability costs of providing traditional broker-dealer services, and, consequently, may make those services too expensive for many lower- or middle-income clients (Headley 2011).

Further, while imposing a fiduciary standard of care may provide additional protections for brokerage customers, critics assert that the imposition of such a standard may result in some customers losing access to financial advice if the cost of that advice rises because of the imposition of the standard, or, alternatively, some customers may find that they will have to pay more for the investment advice they receive without experiencing a significant change in service resulting from the increased regulatory and liability costs imposed by regulation.

In order to test claims that the brokerage industry and its customers would be adversely affected by the imposition of a stricter fiduciary standard, this study surveyed registered representatives (brokers) of broker-dealers in states that impose a fiduciary duty on the provision of investment advice to retail investors, and in states that do not impose such a duty. The survey avoided brokers who are dually registered as investment adviser agents and who, in that capacity, provide fiduciary investment advice. If the presence of a fiduciary duty for brokers results in higher costs associated with that standard, it would suggest that states that impose the higher fiduciary standard have a lower saturation of brokers to households within that state. This would imply that there is an additional service cost attached to imposition of the fiduciary standard by reducing the number of service providers for lower- or middle-income customers.

Differentiating State LawStates were divided into three categories: (1) states that unambiguously apply a fiduciary standard to brokers in that state, (2) states that unambiguously apply no fiduciary standards to brokers, and (3) states where there is evidence of a limited fiduciary standard applied to brokers.

Four states have imposed an unambiguous fiduciary standard on broker-dealers (fiduciary states): California, Missouri, South Dakota, and South Carolina. California, Missouri, and South Dakota courts expressly impose a fiduciary duty on broker-dealers. California courts, for example, have held that a broker’s fiduciary duty requires that he or she act in the highest good faith toward the customer (Hobbs v. Bateman Eichler, Hill Richards Inc. 1985). Missouri courts have held that “stockbrokers owe customers a fiduciary duty. This fiduciary duty includes at least these obligations: to manage the account as directed by the customer’s needs and objectives, to inform of risks in particular investments, to refrain from self-dealing, to follow order instructions, to disclose any self-interest, to stay abreast of market changes, and to explain strategies” (State ex rel Paine Webber v. Voorhees 1995). South Dakota courts have held that securities brokers owe the same fiduciary duties to customers as those owed by real estate brokers, including a duty of utmost good faith, integrity, and loyalty, and a duty to act primarily for the benefit of another (Dismore v. Piper Jaffray Inc. 1999). While South Carolina courts have not expressly stated that broker-dealers must live up to a fiduciary standard, the courts have imposed duties commensurate with those required when a fiduciary duty applies, including a duty to refrain from acting contrary to a customer’s best interest, avoid fraud, and communicate information to the customer that would be in the customer’s advantage (Cowburn v. Leventis 2005). South Carolina courts have clearly imposed a duty of care commensurate with the duty required by a fiduciary that exceeds the suitability standard that applies under federal law to broker-dealers.

States that do not impose a fiduciary standard on broker-dealers are Arizona, Arkansas, Colorado, Hawaii, Massachusetts, Minnesota, Mississippi, Montana, New York, North Carolina, North Dakota, Oregon, Washington, and Wisconsin. Courts in Arkansas, Hawaii, Massachusetts, Montana, and Washington have expressly stated that, under state law, a fiduciary duty does not exist between a client and a broker-dealer. Courts in Arizona, Colorado, Mississippi, New York, North Carolina, North Dakota, and Oregon have all concluded that broker-dealers do not owe a fiduciary duty to holders of non-discretionary accounts. In Minnesota and Wisconsin, state law provides that a broker does not owe a fiduciary duty to customers absent a special agreement between the parties.

The remaining states (Alabama, Alaska, Connecticut, Delaware, Florida, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland, Michigan, Nebraska, New Hampshire, New Jersey, New Mexico, Nevada, Ohio, Oklahoma, Pennsylvania, Rhode Island, Tennessee, Texas, Utah, Vermont, Virginia, West Virginia, and Wyoming) impose either a limited fiduciary standard, or the courts have interpreted state law to impose duties that appear to be fiduciary in nature. In this study, these states are referred to as quasi-fiduciary states. Quasi-fiduciary states impose standards that exceed the suitability standard set forth under FINRA rules, but do not expressly classify broker-dealers as fiduciaries. The duties imposed, and the manner in which they are imposed, vary among these states. In Alaska, for example, courts have found that fiduciary duties arise “when one imposes a special confidence in another, so that the latter, in equity and good conscience, is bound to act in good faith and with due regard to the interests of the one imposing the confidence” (Enders v. Parker 2003). While the Enders court did not specifically consider whether a fiduciary duty is imposed on a broker-dealer, the court’s standard for imposing a fiduciary duty could reasonably be interpreted to create a duty for a broker-dealer in some circumstances.

Other states, such as Connecticut, refrain from imposing an express fiduciary duty, but did find an agency relationship between a broker and a client that required the broker to exercise “reasonable skill, care, and diligence” (Precision Mechanical v. T.J.P Fund 2003). Connecticut’s approach is intriguing in that an agency relationship exists with both the registered representative’s employer (the broker-dealer) and with the customer. Connecticut law, as currently expressed, cannot impose a fiduciary duty on registered representatives due to the inherent conflict of interest created by the state’s imposition of a customer-representative agency relationship, which suggests that the registered representative serves two masters, not one. Iowa courts have not traditionally imposed a fiduciary duty on a broker-client relationship, but do so when certain circumstances exist, such as when the client lacks prior investment experience, the advice offered by the broker-dealer is significant, the client relies (to his or her detriment) on the advice provided by the broker-dealer, and the broker-dealer was aware that the client had not read any literature concerning the subject (McCracken v. Edward D. Jones & Co. 1989).

States that impose a limited fiduciary duty include Delaware, Florida, Georgia, Illinois, Kansas, Louisiana, Maryland, Michigan, Ohio, Pennsylvania, Tennessee, and Texas. Almost all of these states impose a standard higher than the suitability standard imposed by FINRA for non-discretionary accounts. Louisiana does not expressly impose a standard of conduct higher than the suitability standard, but does require a court to consider a variety of circumstances when determining whether a higher standard should exist. The items that Louisiana courts must consider include the relationship between the broker-dealer and client, the nature of the account, and the sophistication of the customer (Beckstrom v. Parnell 1998).

Criticisms of Imposing a Fiduciary StandardDiffering client characteristics have resulted in different business models used by investment advisers and broker-dealers to deliver cost-effective advice to their clients. Imposing a uniform fiduciary standard on both investment advisers and broker-dealers may have unintended consequences.

Some in the brokerage industry have argued that the imposition of fiduciary regulation will lead to reduced consumer access to financial advice, particularly among middle-class households that may not have access to investment advisers. Many broker-dealers provide financial services other than the sale of securities to their clients, including insurance products and brokerage services to qualified retirement plans. The president of the National Association of Insurance and Financial Advisors (NAIFA) testified before the House Committee on Financial Services that broker-dealers are typically subject to both additional state and federal regulation for these services, and these regulations generally provide constraints on behaviors that may be considered abusive (Headley 2011).

Imposing the higher fiduciary standard that currently applies to investment advisers may increase the compliance costs of broker-dealers. A study conducted by NAIFA in 2010 found that an unintended consequence of imposing a uniform fiduciary standard would be to “negatively impact product access, product choice, and affordability of customer services for those customers who are in most need of these services” (Headley 2011). Specifically, the study indicated that imposition of a uniform fiduciary standard may “create the potential for market disruption and reduced choices for investors when it comes to who they work with and how they pay for services” (National Association of Insurance and Financial Advisors (in Partnership with LIMRA) 2010). The NAIFA study indicated that most of its members are “concerned that the additional regulatory requirements and potential legal implications of a fiduciary standard could significantly increase their compliance costs.” (Headley 2011; National Association of Insurance and Financial Advisors (in Partnership with LIMRA) 2010). In the NAIFA study, 65 percent of NAIFA members indicated that if compliance costs rose by 15 percent, they would limit their practice to affluent clients only (31 percent of those surveyed), would not offer securities to their clients (20 percent of those surveyed), or would increase fees for their clients (14 percent of those surveyed) (Headley 2011).

An SEC staff study indicated that investors “generally were satisfied with their financial professionals” (Staff of the U.S. Securities and Exchange Commission 2011), but that customers are confused with the varying standards that apply to different types of financial advisers and, based on this conclusion, recommended the adoption of a uniform fiduciary standard. While the industry raised concerns that imposing a uniform standard that increases compliance costs for broker-dealers may result in limited access to suitable investment advice for middle-income clients, the SEC staff noted the possibility that the change in standards might result in reduced administrative and compliance costs.

Opponents of the fiduciary standard are often criticized for having no data to substantiate claims about increased costs that may arise upon imposition of a uniform fiduciary standard (Consumer Federation of America 2011). In particular, proponents of a uniform fiduciary standard assert that “claims about increased liability costs associated with a fiduciary duty are … unsupported and ignore the legal environment in which brokers currently operate” because “the SEC proposal makes clear that it intends to provide extensive guidance to assist brokers in implementing the fiduciary standard” (Consumer Federation of America 2011). Proponents of a uniform standard claim that the SEC proposal “would not require brokers to charge fees,” and that the proposal preserves “the ability of brokers to offer transaction-based advice … [while] at the same time … rais[ing] the standard that applies to those transaction-based recommendations” (Consumer Federation of America 2011).

Imposing a fiduciary standard on transaction-based advice may increase the potential for legal liability of the registered representative, requiring the broker to be compensated for that additional risk. NAIFA members have expressed concern that the increased duties they owe transactional clients under a fiduciary standard may result in potential legal implications that increase their cost of doing business (National Association of Insurance and Financial Advisors (in Partnership with LIMRA) 2010).

MethodsIn order to estimate how the imposition of a stricter universal fiduciary standard will affect the provision of financial advice within the brokerage industry, we obtained the names and addresses of 544,000 registered representatives active in November 2011, and sorted them into categories based on the application of a fiduciary standard. There are four states that apply a strict fiduciary standard, 14 that apply a limited fiduciary standard, and 32 states (and the District of Columbia) that apply no fiduciary standard.

Our objectives were to assess perceived differences in business conduct among registered representatives sorted by fiduciary regulation and to assess the market saturation (representatives as a proportion of total households) of registered representatives among these states. To assess whether registered representatives’ business conduct differs in states that apply a strict fiduciary standard, we developed a survey among a sample of registered representatives in states that apply no fiduciary standard and states that provide a strict fiduciary standard. The survey was conducted in November and December 2011. Participants were drawn randomly from both categories of states and were asked 12 questions. These questions were based on brokerage industry statements and testimony before Congress suggesting that a stricter fiduciary standard will result in differences in ability to serve moderate-wealth customers, offer a variety of products, and provide product recommendations that are in the best interest of their customers—as well as representatives potentially experiencing a greater compliance burden.

Broker-dealers in fiduciary and non-fiduciary states were asked the following questions:

Are you a registered investment adviser? (If so, survey is over.)What percentage of your clients have incomes of less than $75,000?What percentage has investable assets of over $750,000?Are you able to serve the financial needs of low- to moderate-wealth clients?Do your state’s security regulations limit your ability to recommend a broad range of financial products?Do you offer your clients a choice of financial products that meet their financial needs and objectives?Do you provide advice tailored to the specific needs of your clients?Do you feel that less-affluent clients avoid obtaining your services due to cost?Are you able to recommend products that provide a commission?How significant is the cost of compliance?Do you feel that you make product recommendations that are in the best interest of your client?Among the following options, which do you consider to be the most important single factor in pricing your investment advice to clients: competition in the marketplace, firm brand, personal qualifications, legal and compliance burden, or other?In order to provide insight into whether the imposition of stricter fiduciary standards leads to reduced supply, we compared the saturation of registered representatives within the total population of states sorted into the three fiduciary categories (strict, limited, and no fiduciary standard). Only registered representatives who have completed Series 6 or Series 7 examinations were included in the analysis.1 We provide both a descriptive comparison of saturation among states and a multivariate analysis that includes dummy variables for strict fiduciary and non-fiduciary standards with limited fiduciary as the reference category. Because of the small sample size (50 states and the District of Columbia), we include one control variable to account for the log of mean household income within the state.

New York housed five of the 17 largest broker-dealer firms in the United States in 2011 (InvestmentNews 2012). The saturation of brokers within New York is more than three times the national average and 44 percent higher than the second largest state (Connecticut). Because New York is the traditional center of the brokerage industry and may include a large number of registered representatives not primarily engaged in selling securities directly to individual clients, we include descriptive statistics with and without New York state and include an additional multivariate analysis with a dummy variable to control for the New York effect.

We also estimate the possibility that representatives living within fiduciary states will see less benefit to regulation under the Securities Exchange Act, and subsequently register as investment advisers through the Securities and Exchange Commission. We collect registered investment adviser (RIA) assets by state using publicly available data through SEC filings and compute mean assets per household by state fiduciary status and run a multivariate analysis using the natural log of RIA assets per household as the dependent variable.

ResultsDescriptive statistics summarizing the responses received from a random survey of 207 registered representatives in the four strict fiduciary states and the 14 non-fiduciary states are presented in Table 1. The percentage of clients who have an income of less than $75,000 is statistically equal between both groups, and there is no statistically significant difference in either the percentage of high-wealth clients or in the percentage of brokers who believe they serve the needs of low- and moderate-wealth clients. Nearly all respondents believe they are able to provide products and advice that meet the needs of customers. The percentage who respond that they are able to recommend commission products is 88.5 percent in strict fiduciary states and 88.2 percent in non-fiduciary states. The largest percentage point difference among any of the questions is whether the cost of compliance is significant. Nearly 71 percent of respondents in fiduciary states felt the costs were significant compared to nearly 62 percent in non-fiduciary states. This difference, and that of all other questions in the survey, was not statistically significant.

Mean rates of broker saturation calculated as the number of registered representatives divided by the number of households within the state are presented in Table 2. There is a wide range in saturation rates among states, from a low of 1.31 per 1,000 households in New Mexico to a high of 13.41 in New York. Average saturation rates are lowest among states with a limited fiduciary standard (3.81) and highest among states with no fiduciary standard (6.33). However, the saturation rates were nearly identical among fiduciary categories when New York is excluded from the non-fiduciary states. Saturation rates are 3.96 for strict fiduciary states, 3.81 for limited fiduciary, and 4.04 for non-fiduciary states.

We then take Missouri, an average-size state with a fiduciary standard, and compare it with other states that have a population between 2 million and 3 million households (Table 3). The broker saturation rate in Missouri (2.65) is equal to that of Tennessee (a limited fiduciary state) and comparable to non-fiduciary states with similar income levels (Arizona is 3.12, Washington is 2.54). Other states with higher incomes have higher saturation rates.

In order to control for state saturation differences that may be caused by differences in income within states, we run a regression modeling individual state saturation rate as a function of fiduciary status and log household income. Results in Table 4 show that there is no statistical difference in saturation rates among fiduciary and non-fiduciary states relative to the reference group of limited fiduciary states. When a dummy variable is included to account for the elevated saturation within New York, the coefficient suggests that the saturation rate in New York is 8.3 points higher than the predicted rate. Fiduciary status variables remain statistically insignificant. There is no evidence that the average amount of assets managed by investment advisers is greater in states with either weaker or stronger fiduciary standards, which suggests that representatives within stricter fiduciary states (or representatives with greater assets under management) are no more likely to switch regulatory regimes.

ConclusionsThis study explores the regulation of registered representatives of broker-dealers in order to estimate whether the proposed application of a universal fiduciary standard will have a significant impact on the financial adviser industry. We take advantage of differences in the application of a fiduciary standard to representatives among states in order to test whether representatives already subject to a stricter fiduciary requirement are affected by the higher standard. We conducted a survey of 207 representatives within the four states that apply a strict fiduciary standard and the 14 states that apply no fiduciary standard and find no statistical differences between the two groups in the percentage of lower-income and high-wealth clients, the ability to provide a broad range of products including those that provide commission compensation, the ability to provide tailored advice, and the cost of compliance.

We then compare the ratio of registered representatives to total households among states within the three fiduciary regimes. When New York (which houses a disproportionate proportion of broker-dealer firms) is excluded from the non-fiduciary states, the saturation rate is almost identical between fiduciary, limited fiduciary, and non-fiduciary states. A comparison of a moderate-size state with strict fiduciary regulation (Missouri) with non-fiduciary and limited-fiduciary states of a similar population suggests a strong similarity among states with similar incomes.

A multivariate analysis of broker saturation that controls for fiduciary and non-fiduciary regulation as well as state mean income yields no significant fiduciary effect, even with New York included as a non-fiduciary state. The addition of a dummy variable to account for the New York effect suggests that New York’s saturation rate is inflated by 8.3 representatives per thousand households.

Empirical results provide no evidence that the broker-dealer industry is affected significantly by the imposition of a stricter legal fiduciary standard on the conduct of registered representatives. The opposition of the industry to the application of stricter regulation suggests that agency costs that exist when brokers are regulated according to suitability are significant. Imposition of a universal fiduciary standard among financial advisers may result in a net welfare gain to society, and in particular to consumers who are ill-equipped to reduce agency costs on their own by more closely monitoring an adviser with superior information, although this will likely occur at the expense of the broker-dealer industry. These results provide evidence that the industry is likely to operate after the imposition of fiduciary regulation in much the same way it did prior to the proposed change in market conduct standards that currently exist for brokers.

EndnoteThis constraint excludes less than 5 percent of the original sample and has no impact on the empirical results.ReferencesBeckstrom v. Parnell, 730 So2d 932 (Louisiana Appellate Court 1998).

Acknowledgements: This research was made possible by donations from the Roger and Brenda Gibson Family Foundation, fi360, the Committee for the Fiduciary Standard, and the Financial Planning Association.

(advocate comments: I love it when the industry says things like this "The brokerage industry argues that the imposition of a fiduciary standard will result in an increased risk of a fiduciary breach that would have the effect of increasing the compliance and liability costs of providing traditional broker-dealer services, and, consequently, may make those services too expensive for many lower- or middle-income clients (Headley 2011)." Found inside this study. Another way of reading this statement is that "we need to harm or abuse our clients a little bit in order to make enough money to justify dealing with lower value clients.......and if we could not harm or abuse them in this manner......we would not be able to afford to offer them our "services'......." (Sorry for any sarcasm)

“It’s a crime what’s legal on Wall Street,” is a phrase we used to invoke frequently during my years at Forbes. The topic came up so often because in finance so many practices that are just plain wrong persist for years, and decades, directly under the noses of the financial cops.

Then on occasion, when nobody’s expecting it, something snaps. Too many people lose money. An ambitious government official goes on the rampage. (Note that the terms “attorney general” and “aspiring governor” are often synonymous.) All of a sudden, practices that have been so wrong in so many ways forever suddenly become unacceptable.

That’s what happened with mutual fund market timing and late trading a decade ago. For years, Securities and Exchange Commission officials acknowledged that the once-a-day setting of prices made international mutual funds an easy mark for those who gamed the system at the expense of small, long-term investors. Yet SEC officials did nothing but make speeches. Then along came Eliot Spitzer, who fingered the practices as scams and shut them down in a sweep that even led to a few criminal convictions.

Over the past few years, Wall Street’s collapse has led to a crackdown that’s put more wrongful practices off limits. Banks, for example, face a much tougher time selling worthless credit card “payment protection” plans, can no longer reorder debit card transactions to stick customers with excessive overdraft fees or sue delinquent credit card customers en masse with little or no evidence to support their demands.

Companies that service mortgages can no longer connive with property insurers to foist exorbitantly priced “force-placed” policies on struggling homeowners who’ve let their standard coverage lapse. Likewise, the securities markets are getting more hostile for high-frequency traders, who’ve counted on receiving market-moving news before the rest of the public to profit at its expense.

Good stuff all, but Wall Street remains place where a lot of very bad behavior continues to take place out in the open. Here are some of what I regard as the most egregious examples.

Financial Advisor Chicanery: Imagine a two-tiered health care system in which some doctors were legally obligated to do what’s right for their patients and others, like snake oil salesmen of yore, could recommend whatever treatments made them the most money, as long as they didn’t kill patients outright. Now imagine that the shysters did all they could to blend in with the real doctors. That’s effectively the type of system we have today among the people Americans count on to tell them how to invest their life’s savings. Registered investment advisors must, by law, put clients' interests first. Many thousands of other “advisors” at places like Morgan Stanley, Merrill Lynch and smaller shops are held to a much lower “suitability” standard. In essence, even though these people often refer to themselves as “financial advisors” or by some other comfort-inducing title, they’re really glorified salesmen. Some do a great job serving their clients. Others don’t. It’s up them. Under the law, as long as they avoid putting an 85 year-old widow into an exotic derivative with a 20 year lockup, they’re bulletproof. Few clients know this fiduciary-suitability gap exists. The suitability crowd has worked tirelessly to keep the standard low and the distinctions murky. The cost to the public is incalculable but huge.

Pension Official Payola: Across the country public officials have been funneling growing slices of their trillions of dollars of public pension assets into hedge funds and private equity partnerships that boast high risks and high costs but not necessarily high returns. It just so happens that their fund managers often show their appreciation by investing in the political success of the public officials who favor them. I wrote about one such egregious example in North Carolina a half-dozen years ago. Matt Taibbi took a pass at the story in a Sept. 26 Rolling Stone story tilted “Looting the Pension Funds.” The muni bond market is hardly a symbol of propriety. But at least there underwriters have been banned since 1994 from contributing to public officials’ campaigns. SEC chairman Arthur Levitt tried to impose a similar ban for pension managers in 1999 but lost out to the lobbyists. Now would be a good time for Mary Jo White to try again.

Chairman = CEO Absurdity: A corporate board of directors is legally obligated to represent shareholders. A chief executive is the leader of the hired help. But in over half of U.S. corporations, the chairman and CEO are one in the same. The practice has many fervent defenders, like former JPMorgan Chase (JPM) chairman and CEO William Harrison, who argue that it creates greater cohesion. But it also creates an unjustifiable conflict of interest in which investors are the victims. Is there a chairman in the country who’s going to fire himself as CEO, no matter how dismal his performance? Nuf said.

Management Buyout Mess: The top managers of public companies have a fiduciary duty to maximize shareholder value. Yet sometimes those occupying the boardroom and C-suite get it in their heads that they’d like to buy the company they’re managing. In such cases, the lower the share price falls, the bigger their potential gains. So their fiduciary duty and personal financial interests are diametrically opposed. The answer to this one is simple: ban officers and directors of public companies and their families from participating in management buyouts with no ifs, ands or buts. If you want to buy your employer, quit first and do it from the outside.

SRO Conflict: Think of foxes guarding a henhouse. That’s essentially the franchise the New York Stock Exchange and Nasdaq enjoy as “self-regulatory organizations” with the authority to write market rules and supervise trading activity, along with Wall Street's self-funded watchdog, the Financial Industry Regulatory Authority. Even back in the days when exchanges were nominally not-for-profit, the SROs failed to prevent a steady stream of scandals, including some that indicated the very core of the exchanges’ trading operations were rotten. That included price fixing by Nasdaq market makers and improper trading by New York Stock Exchange floor brokers. Now that the exchanges are themselves publicly listed, the SRO structure is even more suspect and poses new perils. Following the debacle that was the initial public offering of Facebook, Nasdaq sought to invoke its SRO status as form of legal immunity from traders who lost money at the hands of its technological mistakes. Bottom line: Cops and robbers should never live under the same roof. That’s a truism new SEC boss Mary Jo White may be taking to heart.

‘Fairness’ Opinion Unfairness: When corporate boards are trying to convince the world that a merger or acquisition is “fair” to shareholders, they turn to their investment bankers to render an opinion. You might as well ask a barber if you need a haircut. The problem with fairness opinions is twofold: the investment bank rendering the opinion typically has a financial interest in seeing the deal get done; and the directors seeking it may also be looking forward to a change-in-control or other payday that investors aren’t. Bottom line, fairness opinions are a bogus exercise in CYA. Tear down the facade and leave boards to face the legal ramifications of their actions sans the fig leaf.

Revolving Door Debacle: It’s hard to swing a cat without hitting a financier/regulator who hasn’t profited from the incestuous ties between Wall Street and Washington. Treasury Secretary Jack Lew hails from Citigroup. Former SEC boss Mary Schapiro moved to uber-connected advisory firm Promontory Financial. Her SEC successor, Mary Jo White, has made a round trip from government to Wall Street and back again. Sometimes such people do a great job of swapping sides. But in aggregate the result is a blurring of the line between regulators and the regulated. Sheila Bair, the former head of the Federal Deposit Insurance Corp., put it best: "The capture, a lot of people say, is bipartisan. And when I say capture, I'm talking about cognitive capture. It's not so much about corruption. It's just listening too much to large financial institutions and the people who represent them and not enough to the people out on Main Street who want this fixed." In a free country there’s no way, thankfully, to prevent people from job-hopping. Prohibitions on lobbying former government employers are of some value. But what would really help is for the revolving door to swing less between Wall Street and Washington. Imagine the difference if the SEC and other regulators put honest-to-goodness consumer advocates in positions of power to balance out all those Wall Streeters.